Index funds are popular among investors who prefer passive investing. However, there are also many reasons why many other investors avoid index funds.
Lack of Downside Guard
The stock market has proven to be a great investment in the longer run, but over the years it has had its fair share of turbulence and disadvantages. Investing in an index fund such as one that tracks the S&P 500 will give you the upside when the market is doing well.
On the other hand, it also leaves you completely vulnerable to the downside. You can choose to hedge your exposure to the index by shorting the index, or buying a put against the index, but because these move in the exact opposite direction of each other, using them together could defeat the purpose of investing.
Lack of Reaction
Sometimes apparent mispricing can take place in the market. If there’s one company in the internet sector that has a unique benefit and all other internet company stock prices move up in sympathy, they may become overvalued as a group.
The opposite can also occur. One company may have disastrous results that are unique to that company, but it may take down the stock prices of all companies in its sector. That sector may be a compelling value, but in broader market value weighted index, exposure to that sector will actually be diminished instead of increased.
No Control over Holdings
Indexes are set portfolios. If one investor buys an index fund, he or she has no control over the individual holdings in the portfolio. You may have specific companies that you like and want to own such as a favorite bank or food company that you have researched and want to buy.
In a similar manner, you may have experienced that lead you to believe that one company is better than another. At the same time, you have negative feelings toward other companies for moral or other reasons.
Your portfolio can be augmented by adding specific stocks you like but the components of an index portion are out of your hands.
Limited Exposure to Different Strategies
There are countless strategies that investors have used with success. Unfortunately, purchasing an index of the market may not give you access to a lot of these good ideas and strategies.
Investing strategies can, at times, be combined to provide investors with better risk-adjusted returns. Index investing will give you diversification, but that can also be achieved with as few as 30 stocks, rather than 500 stocks that the S&P 500 index would track.
Inadequate Personal Satisfaction
Lastly, investing can be worrying and stressful, particularly during times of market turmoil. Choosing specific stocks may leave you constantly checking quotes and can keep you awake at night. However, these situations will not be averted by investing in an index.
You can still find yourself always checking on how the market is going and being worried ill about the current or prevailing economic landscape.
On top of all of these, you will generally lose the satisfaction of making good investments and being successful with your money.