Why Index Fund Investing Isn’t So Simple, Especially for Ultra High Net Worth Investors

Making the case for ETF and index fund investing is pretty easy. And in fact, Pillar has made the case many times (such as in this guide) because of the much lower costs and fees associated with index investing.

But if we just stop there, that leaves many high net worth investors wondering: If all I have to do is use index funds for my investments, what’s the big deal about financial planning?

The short answer is: Nothing is that simple. Index fund investing is no different.

For a more in-depth exploration, let’s look at some questions and principles related to index fund investing that expose some of the underlying complexity, as well as the inadequacy of assuming you can just use index funds and ETFs and simply ‘set it and forget it.’

Index Fund Diversity – Not All Indexes Are Created Equal

Choosing to invest using index funds and ETFs is easy. But choosing which indexes and ETFs to invest in is much more challenging. Why?

Because just like any investment category, some options will perform much better than others. Some entail more risk but greater potential reward. Some are more conservative and stable. Some are more volatile due to specific industries or companies they focus on. Some (like the DOW) are just plain overrated. The DOW only includes 30 companies. Investing in an index fund tied to the DOW entrusts your money to the vicissitudes of a pretty small slice of US companies, albeit large ones.

Even more difficulty arises when an index or ETF experiences some internal upheaval.

For instance, what happens if a key sector or group of companies in your chosen index fund falls out of favor? Will you stick with that index or look for a new one? And what percentage of your investable assets should you allocate to each index fund you choose?

Two common myths about index funds, according to US News & World Report, state that they are safe and always perform consistently. They aren’t, and they don’t.

Index funds rise and fall with the market. If the market crashes, so do the index funds. And sometimes the equities comprising a fund may have been assembled based on questionable assumptions about prior performance. Not all indexes are equally safe. And some have higher expense ratios and more turnover, which increases your costs.

Choosing the optimal index funds for your situation requires in-depth analysis. For ultra high net worth investors, this single choice can mean a difference of millions of dollars over the life of your investments.

You don’t want to get it wrong.

Asset Allocation Trumps Index Investing Every Time

If index investing were so simple, why not just stash 100% of your money in the same index fund? As an index, it should be inherently diversified, right?

The problem is, asset allocation and diversification are distinct concepts. Yes, 100% investment in the same index is technically diversification. But it’s not a healthy allocation, because if the market collapses, that index fund will collapse with it, and you have no buffer to protect you.

Therefore, you need a more nuanced allocation that combines a variety of equity investments as well as bonds and cash.

But which indexes? Which bonds? How much should be in each? And what if you own substantial real estate? How should that affect your investable asset allocation?

What Happens When Your Index Funds Perform Well?

Healthy asset allocation also demands regular rebalancing.

Suppose you have 55% of your money invested in equities, almost all in indexes and ETFs. And then you have 30% in bonds and 15% in cash. A fiduciary financial advisor who has a process that projects your investment performance and financial security for the rest of your life can determine the exact asset allocation you need.

To see what Pillar’s process projects for you, schedule a free Wealth Management Analysis meeting

Supposing your advisor determined 55/30/15 to be the right allocation for your lifestyle, optimized investment performance, and long term security. If your equities perform well, that 55% will eventually grow to 60%, and continue to grow higher.

Left unchecked, you will eventually become out of balance and develop an unhealthy (for your situation) asset allocation. The solution is to rebalance by shifting the growth from the equities back into the other sectors.

But how much do you shift from each index fund you have invested in?

Make the wrong choice, and your performance will suffer, and you might fall below that 55% equity allocation. Then, you’d be forced to rebalance again, but in the other direction.

This little ‘rebalancing’ dance needs to happen consistently if you want to achieve the highest, most optimized performance. Unless this process is managed by a wealth advisor who has developed a customized plan that optimizes your investments and exceeds ALL your long term goals and lifestyle plans – you will likely fall short of your goals by making misinformed choices.

Strategic investment planning and performance depend entirely on the plan that directs them.

Who will help you develop your own customized plan? Just throwing money into index funds that seem good to you isn’t a plan. It’s a gamble.

How Much Money Do You Want to Leave Your Heirs?

Suppose you have $10 million, and want to leave $12 million to your heirs when you die. But you’re 50 years old right now. You’ve got a lot of spending and living and investing to do.

A lot will happen between now and when you die.

Do you have a method to ensure you will still have $12 million left when you die? No matter what happens in the stock market, the global economy, your own family, or your business?

Customized high and ultra high net worth investment planning helps you answer this fundamental but rarely-asked question with specificity and reliability.

For most of our clients, we find investors need something other than an all-index investment portfolio. Each situation is different, because each life is different. What you need will not be the same as what the next investor needs.

That’s why talking about your investment preferences at cocktail parties is pretty useless. What does the person you’re talking with have in common with you?

Are their kids the exact same age as yours and facing the exact same life situations?

Are your parents and their parents in the exact same predicaments?

Does your family have the same health status as theirs?

Are your lifestyle plans and hopes the same as theirs?

Do you share their philanthropic goals?

Hopefully you are realizing the futility of pursuing an investment strategy simply because it’s working for some other guy. Simply sharing the ‘high net worth’ classification with someone else only puts you at the same cocktail party. But it does little more than that when it comes to your investment planning.

More Questions that Complicate Your Investment Planning

What if you end up facing several large, unplanned major distributions?

These could be things like long term care costs, medical bills, business expenses, unexpected major life setbacks, or many other things.

What if you live far longer than you expect? Or the reverse, but your spouse outlives you by a couple decades?

Here’s a question much more down to earth:

How much do you want to spend each month to sustain your desired lifestyle?

Can you afford that level of spending? Maybe it can be even higher. How can you determine with certainty the highest level of spending that still ensures your long term financial security, and that won’t leave your heirs hanging out to dry?

Simply investing in index funds and ETFs answers none of these questions, or the many more we could pile on if you remain unconvinced.

The index-only, set-it-and-forget-it investment approach denies the reality of the complexity and unpredictability of life. Life will intrude on your plans. Your goals will change. This is one of the few guarantees about investing. No one’s goals remain unchanged for the rest of their life. No one’s.

And when those goals change, of necessity your investment plan must change with it or it becomes obsolete and useless.

Suppose you face a major unplanned distribution and have to liquidate one tenth of your assets.

How will you adjust your portfolio in the aftermath?

Or what if the reverse happens, and you receive an unexpectedly large inheritance?

What will you change in your investment plan as a result?

What if the market collapses two years after you retire?

The Only 5 Things You Can Control with Regard to Money

You can only control five things related to your money. When planned and unplanned events and changes impact your life and portfolio, including the ongoing need to smartly rebalance your assets, you only have five choices for how to respond (or a combination of these):

1. How much you spend

2. How much you save

3. The timing of your planned major distributions

4. Risk tolerance

5. The legacy you want to leave

That’s it.

When life happens and you have to make changes to your finances, these are your five options. You can increase or decrease your spending or savings. Adjust the timing of your planned major expenses. Adjust your risk tolerance in either direction. And increase or decrease the amounts you plan to leave to heirs and charities.

So what changes will you make, and how drastic will they be?

How can you know after making those changes that your long term security remains ironclad?

Index Investing Is Just One Highway on the Map

Wealth planning that ensures your long term financial security involves far more than just choosing to invest in index funds. That’s just one segment of the financial road you’ll be on from today through the end of your life. Hopefully you’ve now gained a greater appreciation for why that’s true.

Your next question should be, how can I answer all the questions I’ve just read?

There is a way.

Sign up for a free Wealth Management Analysis meeting

In this meeting, you will be shown how your current investment plan and asset allocation will perform for the remainder of your life. You’ll be given tax minimization and estate planning strategies. You’ll be shown how randomized ‘what-if’ scenarios affect your investment performance, even decades into the future.

But most importantly, you will be shown – with a proprietary data-based process behind it – what you can do to achieve lifelong financial security.

In other words, you’ll find out which of those five areas of control you need to adjust, and by how much, to ensure your new financial plan stays healthy for the remainder of your life.

You’ll get the answers you need.

It’s a free meeting. You have nothing to lose, and many years of financial serenity and enjoyment to gain. Click the button below to schedule your Wealth Management Analysis meeting.

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