5 Reasons Index Fund Investing is Better than Stock Picking

I don’t think there is any confusion. But let me say it outright from the jump…I am a huge advocate of index fund investing. Especially for high income earners, I think it is really the only reasonable approach to equity investing for most or all of your nest egg.

However, despite pronounced advantages and practical logic, index fund investing still gets labelled as boring or unimaginative or lame but a ton of investors.

And stock picking, whether in the form of investing in individual stocks or actively managed index funds, has tons and tons of proponents.

In fact, I’d be willing to bet that most physicians and high income earners are involved actively in stock picking rather than index fund investing.

Of course this is due to the indiscriminate use of financial advisors by doctors. And underscores the important of finding the right financial advisor if you decide to use one. (These questions will help you do this successfully…)

Anyway…let’s get into why index fund investing remains the champ…

5 reasons index fund investing is better than stock picking

Not to be too aggressive from the start but…

1. It just works better!

Studies have continually shown that over a long period of time, passive investing outperforms active investing 80-85% of the time!

Passive investing is index fund investing. Active investing is stock picking via individual stocks or active mutual funds.

And the investors in these studies are not you and me. They are professional investors. On Wall Street.

If they can’t beat the market average with all of their experience, knowledge, and data, how can we expect to? And why would we trust our local financial advisor to do it? It defies logic. And yet, many still do it. Don’t be like those people.

And don’t throw whatever hand full of active managers have beat the market in a previous year or stretch of years. History is rife with these tail events and outliers. History is also rife with the same managers losing all of these gains in subsequent years…

2. It’s not how much you win, it’s how much you don’t lose

As high income earners and doctors, we are at an advantage in the investing game. We make in the top 1% of income. Regardless of what type of doctor you are.

That means that you can use a simple formula of saving 20% of your gross income and investing passively to reach your goal nest egg and retire on your terms.

And I can prove it to you right here! (You can also access a free calculator to run your own numbers here.)

What I am getting at is that it’s your savings rate that will impact your ability to retire on your own terms more than your investment returns. Especially at the beginning of your investment career.

So, your focus should not be about chasing the highest returns possible. As a high income earner saving at least 20% of your income, you just don’t need to take on the risk associated with chasing these high returns.

You don’t need to hit home runs. Just keep hitting singles and doubles. (Forgive the baseball analogy…)

By chasing high risk, high return investments like stock picking, you expose yourself to big losses that can have a huge impact on your ability to reach financial freedom. You don’t need to win the biggest. You just need to lose the least…

Related Post:
How Much Is Enough Retirement Savings?

3. It costs so much less

When you fill up your retirement buckets with savings and investments, there are two variables dictating how full the bucket gets:

• How much water you put in, and
• How little water you let leak out

It’s that simple.

And if you put in as much water and leaks out, you don’t actually gain anything. And over time, a small leak can really eat into your hard savings.

The biggest leaks in your buckets are:

• Fees, and
• Taxes

And guess which investment strategy has more associated fees and taxes (like by a lot)…

That’s right. Stock picking!

Stock picking means buying and selling stocks actively. Maybe it’s daily, weekly, monthly…whatever. But there is actively and (relatively) more frequent buying and selling than with index fund investing.

And with each purchase and sale, fees and taxes are incurred. And you as the investor pay them.

On the flip side, index funds by definition stay pretty much constant. That means minimal buying and selling. That means minimal taxes and fees. That’s why index fund are notoriously low cost.

Index fund investing can realistically save you, as a high income earner, hundreds of thousands of dollars over your investing career!

(As an aside, you need to make sure that the fund you are investing in is a true index fund. Some will advertise themselves as an index fund but have a really high turnover rate. This means there is a lot of buying and selling going on. That means it’s not really an index fund…)

4. Less stress

Again, when you invest actively with stock picking, you are saying that you believe in that company’s success. If you are right, like with Apple, you make a lot of money. If you are wrong, like Enron, you lose all of your money.

When you buy the whole U.S. stock market, you are saying that you believe in the overall ingenuity and innovation of humankind and the U.S. economy

So if you make this bet and you are right, you make money. If you are wrong, the economy and civilization as we know it collapses. Your portfolio will be the last thing on your mind. Everything to gain and nothing to lose.

Betting on the whole stock market is a much safer bet.

If you have to constantly guess correctly in order to reach your goal retirement nest egg, that’s a lot of stress on a literal daily basis. Added on top of the regular daily stress or being a human being (and doctor).

I know I don’t need that.

I’d rather sit back, know I just need to rebalance my asset allocation once a year. The rest of the time, I just completely ignore the stock market….

Related Post:
Asset Allocation and Rebalancing: A How-To Guide for Buying Low, Selling High, and Relaxing In Between

Which leads me to my last point…

5. It’s (so much) easier

I just said it above.

The only work involves in my stock market (index fund) investing strategy is as follows:

• Create an asset allocation
• Buy index funds according to that asset allocation
• Rebalance back to my pre-determined asset allocation once a year

All in all, this takes conservatively 2-3 hours.

But steps 1 and 2 account for 3/4 of this time. Once you decide on an asset allocation and use it to create your written financial plan, this takes about 15-30 minutes a year.

Related Post:
Creating My Universal FIRE Equation

On the flip side, let’s examine stock picking…

Do you play fantasy football? If so, no explanation is really needed. But if you don’t, let me set the stage.

In fantasy football, you draft a roster of football players. But each week, there are undrafted players on the waiver wire. And each week, some of these will be hot pick-ups that every team wants for one reason or another. A lot of times, the reason is because some player got hurt and now his back up is a hot commodity.

Well, as a doctor, I am always at a huge disadvantage when it comes to the waiver wire compared to my friends in my fantasy football league.

Why?

Because I’m usually the last to hear about this breaking news! I’m doing doctor things. Or family things. Or real estate investing things.

Well, this is exactly like stock picking. Do you want to have to be constantly aware of these micro-happenings in the financial and industrial world to try and make a guess that is wrong 85% of the time (for experts)?

I don’t have that time. And I’m guessing you don’t either.

Why not just chill and know that we are beating these active investors 85% of the time anyway?!

And the bell rings! The fight is over! Index fund investing wins! But you can still scratch that itch…

I hope I’ve demonstrated why index fund investing is just so much better in general. But especially for high income earners that don’t need to chase high risk returns to reach financial freedom.

But, some of you will still feel the itch to invest actively with stock picking.

And the good news is you can still scratch that itch! Take 5% of your portfolio and invest actively. Pick individual stocks. Put money in the hottest new active mutual fund. Even if it tanks, 5% of your portfolio sent going to make or break your financial plan.

Maybe it even helps you get more comfortable with the idea of just investing passively in the market as you find yourself more and more in the 85% underperforming the average…

You can learn more here about stock market investment made stress-free, how to create and rebalance your asset allocation, where to put your investments, and how to create your own written financial plan!

And please avoid these 3 tempting investments!

Also don’t forget to check out my free masterclass webinar on The 12 Steps to Financial Freedom for Physicians!