Index Funds vs Stocks | Stock Market For Beginners

Index funds vs stock picking watch from 0:00

In today's video, we're going to get to the bottom of this. Index funds versus stocks, which one is better? Index fund investing or stock picking? Which one produces better results? I'm going to save you the drama. I'm going to tell you right now. Generally speaking, when the stock market is going up, when you're in a bull market, an index fund will outperform stock picking. When the stock market is going down, when you have a bear market or a crash, stock picking or active managements outperforms index funds. Now, you have to know this piece. This is so important. The stock market goes up more than it goes down.

So, in the past 50 years, the stock market has gone up in 40 of those 50 years. The average duration of a bull market is 3 years. The average duration of a bear market is 10 months. Of course, the time frame that you're looking at when you're analyzing it, of course, that's going to change the figures, but generally speaking, it's in that range.

When to use each strategy watch from 1:04

So, I'll tell you this. Even if you're not a beginner in the stock market, what I just told you is very educational information. That's very insightful. But even if you're equipped with that knowledge, does it answer the question, which one is better? Index fund investing or stock picking? Well, you could make the arguments that I just said that index funds, you know, they outperform when the stock market is going up and the stock market goes up more than it goes down. So, you can deduce that index fund investing is better. If that's what you're thinking, that in most situations and for most people, I would say that I agree with you and I would say that you're absolutely right.

However, this is not one size fits all. People have different goals. People have different financial objectives. So, does index fund investing generally outperform stock picking? And the answer is yes. Is index fund investing for everyone then? I would say no, and I'll tell you why.

Goals of active vs passive watch from 2:07

So, you at the very base at the very foundation of this, you have to understand the fundamental difference. What is the purpose of stock picking or active management? The purpose is to beat the market. So, what is the purpose of index fund investing? It is to match the performance of the market, nothing more or nothing less. So, if your goal is to become a superior investor, then you can't just stick all your money to an index fund that tracks the S&P 500 because if you do that, then you're never going to beat the markets, and you will never achieve your goal. So, we're going to play devil's advocate here.

So, the reality of the situation is that a lot of people, amateurs and pros, attempt to outperform the markets. And some investors, they do. They consistently beat the market even in bull markets. But, the majority of investors fail miserably even in bear markets. So,

Warren Buffett's famous bet watch from 3:05

people want to become the next Warren Buffett, and you know, I don't blame them. So, you This is actually a good segment to tell you what Warren Buffett thinks about index fund investing. So, Warren Buffett says that most investors are better off using index funds instead of trying to pick stocks. In 2007, Warren Buffett was so confident about this that he made a wager. Buffett bet a New York City money management firm that over the next 10 years, an S&P 500 index fund would do better than five hedge funds. So, fees, expenses, and all that would be taken into consideration. So, the wager went from 2008 to 2017.

After the 10 years, the five funds had an average return of 36% over those 10 years. So, that's about a 3.6% return annually. Buffett went with the Vanguard index fund tracking the S&P 500. It went up 125%. That's 12 and 1/2% a year. So, after the conclusion of that wager, Buffett wrote a letter to shareholders. He said that small and large investors should stick with low-cost index funds.

Market performance data watch from 4:20

Now, I want to pause here for a second. I know that we're already deep into this video, but I want to tell you this. I'm just trying to be helpful. If you do not have a solid understanding of index fund investing, like the pros and cons, please check out my video about index funds for beginners. It's going to do you a lot of good, and this video would make a lot more sense if you watch that video first. But, moving on, I want to give you some hard facts. These are the stats. Over the past 50 years, the S&P 500 index has averaged an annual gain of 10.4%.

So, this assumes that dividends were reinvested. Over the past 30 years, it's averaged an annual gain of 9.7%. Over the past 20 years, it's averaged an annual gain of 10.3%. So, if you noticed, it's pretty consistent. 20 years, 30 years, 50 years, 9 to 10% returns. So, that's what you can expect. And I think that Well, I think that's a good sample size.

Active management in bear markets watch from 5:25

So, here's some more stats for you. The Standard & Poor's has been tracking the record of active managers. In their report last year, they cite that after 5 years, 84% of actively managed funds have underperformed their benchmarks. So, they're not cherry-picking the data, either. They're not cherry-picking it with the 5-year time frame, because when you look at the 10-year when you look at a 10-year time frame, it's actually 90% of active managers underperform. So, it's actually worse. They noted that one reason one of the various reasons why is because fund managers they do too much trading which compounds investing mistakes. So, I imagine that it's the same thing is probably amplified with amateur stock pickers as well.

However, as I told you before, active management outperforms when the stock market is going down. So, in the past 10 years, only 10% of active managers have beat the markets. But in 2022, when the stock market was going down, 49% of active managers beat the markets. So, I want to tell you what's going on. When the stock market is going up, the easiest way to make money is to keep riding the wave with the same winning stocks. And that's something that index funds do automatically. But when the stock market abruptly shifts from bull market to bear market, that stops working. Or if there's a rotation from one sector to another, let's just say from tech stocks to value stocks, stock pickers are better at picking the winners in that rotation. So, those are the stats. That's the situation and you can interpret the data however you please.

Best practices for index investing watch from 7:04

Now, this is my recommendation to you. Index fund investing is appropriate for most people. In my opinion, it's hard to screw up index fund investing, but you'd be surprised because people do it all the time. So, I want to tell you how to not screw up index fund investing. So, the first thing is that you need to have a long-term approach, a long-term mentality. So, I told you the returns over that time frame, those time frame, 20 years, 30 years, 50 years. Even if the stock market crashes, if you take a long-term approach, it's all going to even out. But if you don't have a long-term mentality, you could get hit by a very bad year and it could crush your portfolio.

So, in 1974, the stock market went down 29%. In 2002, it went down 23%. In 2008, the market went down 38%. One bad year, it could devastate your returns if you have a short-term approach. The second thing that I recommend is that if you're going to be an index fund investor, then you have to stay consistent with your contributions. This is important because if the stock market crashes in a given year, that is actually the best time for you to deploy your money. That is the worst time for you to not contribute. And if you're not consistent and you miss that year, that's going to really drag down your overall returns. Okay, so that is how you minimize your chances of screwing up index fund investing. I don't want to I don't want that to happen to you.

The core-satellite approach watch from 8:38

Now, the second thing I want to say is that and this is my opinion. When it comes to index fund investing, you don't have to make it an all or nothing approach. A lot of people use a strategy and it's called the core and satellite approach. So, this is when you invest the bulk of your money in index funds, but you're still allocating some money to pick stocks that you think will be winners. So, some people disagree with this and they say that you should invest 100% of your money in index funds because you know, it's better. But, I see the core and satellite approach as a good and acceptable middle ground.

Also, if you want to actively manage your own portfolio, like you want to pick stocks, I want to give you a recommendation. So, I personally pick stocks because I enjoy doing the research. I like studying the trends. I mean, a lot of that is what I share on YouTube. And honestly, I would be doing this research anyways even if I was not on YouTube. So, I pick stocks. However, I will use index funds to complement my stock picks. So, I want to give you an example. Let's just say that I pick a bunch of tech stocks, right? And I realize that, hey, my portfolio is really tech-heavy.

I need to add some real estate exposure to my portfolio. Then I can buy an index fund for REITs. It would be the same story if I wanted to add exposure to energy or bonds or international or even pharmaceuticals. It could be used as a complement to whatever you're lacking. So, in this scenario, index funds are the satellites in addition to your core holdings, which are the stocks that you pick and actively manage. So, that's the way I see it. That's the way I treat it. So, if you do want to see my stock picks and you want exclusive investing content, please check out our website. It's clearvalueinvesting.com. Going to leave a link down below. Please subscribe. I thank you for the support. I wish you a very nice day. Take care.