I understand the concept behind index funds -- I loved Bogle's books on the subject -- but I wonder if it still makes sense, at least in the USA. Caveat: I know just enough economics to be dangerously uninformed. ;)
The all-market index fund is an expression of faith in "the system". I am a bit concerned that markets in the US just aren't what they used to be in Bogle's heyday. I look at the housing crisis and I see entire industries based on large-scale dishonesty or incompetence, with no serious oversight from Congress or the press.
Everyone assumes that the USA is a big machine for creating value, because it always has been. But is there really any evidence for this in the past 10 years? At this point, we've wiped out most of the gains since 2000. If you disregard the various bubbles, did anything really get done?
Bogle himself warned that American capitalism, since the late 80s or so, has been abandoning its old principles of rewarding risk-taking and investment. The American economy is now dominated by an elite managerial class, rewarding itself regardless of performance or economic sanity. Bogle called this "managers' capitalism". Economist George Akerlof bluntly calls it "a form of looting".
Vanguard has foreign and industry-specific index funds to address weirdos like me, but in a sense that's the sort of stock-picking that the index fund was designed to avoid. I still feel confused by it all.
At this point, we've wiped out most of the gains since 2000.
So much to say about this, so little time.
First: I sat out of the market for several years after the 2000 crash. That cost me a bunch of money! Be careful not to make my mistake.
Second: The correct time to fret about pouring money into an overvalued stock market was three years ago. Now is not that time. Now is a much better time to buy, not to panic. Perhaps the market will crash some more and it will be an even better time to buy next year!
But no. Scratch that. The correct time to fret about investing is "never". You've got to employ a strategy that does not involve market timing, which is what you're doing when you sit on the sidelines wringing your hands. You are implicitly predicting that the market is going to fall some more. And you might be right, but you also might be wrong, and if you're wrong it will cost you.
(Unless, of course, you're 74 years old and can't afford to wait twenty years for a recovery. Asset allocation is a difficult art because it depends on personal circumstance. This is why, in a sense, there's no such thing as an "investment climate": There are millions of investment microclimates. You can't base investment behavior on what the herd is doing. For example, articles in the news are going to be filled with doom and gloom for a while, because much (if not most) of the large baby boom cohort is old enough that it's hard for them to wait out a major depression, and they will need to vent their misery. But their investment problems may not be your investment problems.)
What you need to do is diversify. Which brings me to point two: Anyone who was following a wise investment strategy would not have "wiped out all gains since 2000". That's because perhaps about 30% of your asset allocation (maybe more) should be in bonds, and you should rebalance every couple of years. So when stocks have a bubble and double in price, you sell stocks at rebalancing time and buy a bunch of bonds. Then, when the stocks inevitably crash again, the bonds remain, safe and sound. [1]
People yawn at bonds, particularly government bonds. They're just so boring. They don't post those spectacular gains that you'd get from day-trading technology stocks. But the thing is: they also don't crash in the same way that corporate stocks do. Their price movements are often opposite to those of stocks, or at least poorly correlated. Their risk profile is quite different. They are your buffer against the distinct possiblity that all of your stock gains are based on the maneuvering of dishonest, incompetent con artists -- which is okay, so long as the con artists represent only a portion of your assets.
Anyway, just read the Bernstein book. I can't retype the whole thing here.
I will say that your instinct to buy foreign funds is a fine one; it is not "weird" by any means, and it's not the same as stock-picking or market timing (Unless you change your asset allocation every five minutes. Don't do that!) You probably want to keep 30% to 40% of your stock assets in foreign stocks. I do wish it was easier to buy foreign bonds or currencies as well -- they tend to be restricted, or to be available only through funds that charge fees which threaten to eat up any small advantage that you'd get from the extra diversity. I've been toying with solutions to that problem.
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[1] Of course, economic problems with global might take down the value of every asset at once -- we can't diversify to other planets. But at least you won't be alone in your pain if that happens.
The all-market index fund is an expression of faith in "the system". I am a bit concerned that markets in the US just aren't what they used to be in Bogle's heyday. I look at the housing crisis and I see entire industries based on large-scale dishonesty or incompetence, with no serious oversight from Congress or the press.
Everyone assumes that the USA is a big machine for creating value, because it always has been. But is there really any evidence for this in the past 10 years? At this point, we've wiped out most of the gains since 2000. If you disregard the various bubbles, did anything really get done?
Bogle himself warned that American capitalism, since the late 80s or so, has been abandoning its old principles of rewarding risk-taking and investment. The American economy is now dominated by an elite managerial class, rewarding itself regardless of performance or economic sanity. Bogle called this "managers' capitalism". Economist George Akerlof bluntly calls it "a form of looting".
Vanguard has foreign and industry-specific index funds to address weirdos like me, but in a sense that's the sort of stock-picking that the index fund was designed to avoid. I still feel confused by it all.