Public Service Announcement: Invest in Index Funds

PSA: Invest in index funds

We live in a sort of reverse Victorian age: it’s easier to talk of sexual matters than of money [1]. I have recently been surprised at how ignorant even highly educated Europeans are about their financial possibilities [2]. I meet people with large sums in savings accounts where the money is just sitting there or in hare-brained “investment” schemes. So, this is a bit of public service announcement, although there is a particular point that applies mostly to scientists.

Invest in index funds. An index fund is a fund which buys a large number of stocks to mimic an index (for example, the stocks that make up the S&P 500 index). You want ones with low fees (<0.5% per year). For diversification, you might buy more than one, but seriously it does not matter what you have as it’ll always be better than nothing or a savings account (savings accounts are paying 0.3% in Europe).

You should just assume that markets are efficient, Now, there is a debate in academic circles whether they are 99.9999% efficient (i.e., people who think they are efficient) or only 95% efficient (people who disagree). But even if there are market inefficiencies, they’ll be exploited by professional hedge funds, not by you in your free time! So, just assume that markets are efficient, assume that you cannot beat them, and strive to minimize the amount you pay in fees [3].

Index funds are investment, not speculation: your goal is to collect dividends, not necessarily have the fund rise in price! If you buy a fund at the price 100 and later sell it at the price of 90, you might still have made money if you made more than 10 in dividends [4]. More typical however, is that you buy at 100, sell at 116 a few years later and will have collected 82 in dividends over that period (Some people don’t even know this basic fact of how these things work and are surprised when I mention dividends as a large part of the return I expect from my investments).

To buy these, you need a brokerage account. I use TD Direct Investing in Europe, but others exist. Your bank will generally not help you and will try to sell you products where they make large fees (it’s like going to a Chrysler dealer and telling them you know that Toyota/Honda have much better value for money, but could they please help you choose between an Accord and a Camry? [5]).

Do not pick stocks as it can lead to conflicts of interest I could again just say don’t pick stocks, assume markets are efficient, but an additional reason for me (and for any scientist) to avoid owning individual stock is that owning stock of particular companies is a conflict of interest if you ever have to evaluate anything which touches (even peripherally) on anything the company does. Note that a conflict of interest will not immediately translate to a bias and the practice in science is to disclose the conflicts without completely dismissing the speaker, but if you’re writing scientific papers or reviewing them, why force yourself to disclose a conflict when you could just as easily avoided the issue by not owning the stock in the first place? Further, it is an unnecessary risk that you unintentionally fail to disclose and someone will later point out that your paper on how X protein binds with Y protein conveniently fit with your ownership of pharma P’ stock as they have a large investiment on an X-inhibitor [6]. We scientists already have to spend too much time defending ourselves of the accusation that we are just flaks for Big Pharma or Monsanto, so just don’t own their stock.

If you’re thinking about buying gold, consider buying a gun instead. This is tongue-in-cheek, but there is this persistent idea that owning gold is a good idea because when the revolution comes, money and stocks will be worthless as civilization collapses. But when civilization has collapsed and we are all back in the state of nature where life is nasty, brutish, and short, a gun is even better than gold.

If you have gold and your neighbour has a gun… well, at the end of the day, your neighbour will still have the gun, but you might have lost your gold. When civilization collapses, you’ll want to be the one who knocks. So, if you’re worried about the incoming collapse of civilization into a Hobbesian nightmare, consider buying a gun. [7]

Back in the real world, gold is still a bad proposition, subject to volatile prices. Volatile means that (1) you can make large profits if you guess the time to sell&buy and (2) you can lose a lot of money by guessing wrong. However, you will likely not get the timing right. More importantly, unlike stock/bonds or real estate, there is no inherent income stream from holding gold. You are just betting that the price will go up. In recent years, perhaps because of the recent strong growth in the world economy, particularly in China and India (Indian culture is obsessed with gold) or perhaps because of rich people panicking (or whatever [8]), the prices of gold have risen (although volatility is high: just last week, it lost 10%). However, by buying now you might just be buying at the top of the growth curve [9].

§

Introductory pop intro to this stuff

I will teach you to be rich by Ramit Sethi. Pretty basic stuff. One important point: if you do get a financial adviser, get one paid by the hour; not one that gets paid by commission. You want to talk to an adviser, not a salesman.

[1] Arguably, much discussion of sex is not fully honest, particularly of the emotional/sexual nexus. Still, the point remains: it’s easier to get someone in bed that to discuss their financials.
[2] Americans tend to be a bit better because there is less fatalism wrt retirement. Many young Europeans are aware that their public pensions will be less than they were promised even just a few years ago, but they often just adopt a whatever will be, will be attitude. There may be increasing interest in alternatives to putting your trust on the promises of politicians, but ignorance is still rife.
[3] I actually believe a pretty strong version of market efficiency and I think that the large profits of financial corporations come from rent-seeking (i.e., taxpayer bailouts) and charging high fees for things that are not worth a lot. Still, even you think that markets are not that great and that there is a lot of potential to earn money by being better than the markets, then it is still likely that it will not be you who’ll do it.
[4] The example does not work so well for Europeans as a Fiat is much cheaper in Europe than Honda here so it’s not so obvious that the Honda is better value for money as Fiats.
[5] Some funds do not pay dividends per se and instead are engineered so that the dividends from the stock they own get translated into a higher price even if the underlying securities has not moved in price. This has some tax advantages in some jurisdictions, but it works out to be the same.
[6] Nowadays, stock ownership is rarely mentioned as an important conflict of interest in published papers, but who knows how ethical fashions will evolve and where your career will be in 10 years when an enterprising journalist decides to expose you as the Monsanto-fundede Big Pharma flak that all scientists really are.
[7] My guess is that guns hold their resale value, making them a good store of value, but I couldn’t really find data on this.
[8] This is another dependency on external factors that could potentially be a conflict of interest.
[9] I’d write top of the bubble, but I don’t think bubbles are a very useful concept. Gold is still as likely to go up as to go down or just to stay the same. If it goes down, we’ll retrospectively call it a bubble and whoever buys now will be labeled a sucker; in that case it’ll be obvious we were in a bubble now. If it doesn’t go down, well it will be obvious that gold is now a golden opportunity
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