Won't Index Investing Produce more Money?

In this episode of Yield to Reason Podcast, host Brandon Roberts tackles one of the most common arguments against income-focused investment plans: "Won't I have more money if I simply invest passively in the S&P 500?" Brandon breaks down the theoretical appeal of index investing versus its practical application in real-life retirement planning.

Key Points Discussed

The Perceived Perfection of Index Investing

• Index investing is often positioned as the ultimate investment choice
• Passive index funds/ETFs allow investors to capture U.S. stock market prosperity
• Requires minimal investment sophistication
• Market data largely supports this strategy on paper

The Reality Gap: Why Perfect Plans Sometimes Fail

• Well-conceived investment plans with solid data can break down when faced with real-life variables
• Similar to how engineering designs may face implementation challenges
• Index investing faces practical vulnerabilities despite its theoretical strength

Major Risks of Index Investing

Market Downturns

• Paper losses create psychological harm for investors
• Panic selling during downturns can convert temporary losses to permanent ones
• Market recovery timelines may not align with individual retirement timelines

Historical Recovery Periods

• Great Depression: 25 years to recover losses
• Dot-com bubble and 2008 recession: approximately 6 years to recover

Timing Risk (Sequence of Returns)

• Investors cannot control market return order
• Timing has dramatic impact on portfolio performance
• Particularly critical for those approaching or in retirement

Real-World Comparison: Index vs. Income Strategies (1999-2024)

• $100,000 initial investment with $5,000 annual contributions
• VFINX (Vanguard S&P 500 index fund) vs. CEF (Closed-End Fund) portfolio
• VFINX fell below CEF during dot-com crash and didn't catch up until 2018
• End of 2024: $385,000 difference between portfolios
• Distribution comparison: CEF generated $104,000 vs. VFINX's $15,400
• 4% withdrawal from VFINX would yield $54,000 - almost half of the CEF portfolio's income

The Income-Focused Advantage

• CEF distributions continued uninterrupted through market volatility
• Income remains stable regardless of share price fluctuations
• Investors aren't forced to sell shares during market downturns
• Option (not requirement) to sell shares for gains and reinvest

The "Good Enough" Philosophy

• Pursuit of more can sometimes be financially detrimental
• Recognizing when you have enough is key to retirement security
• Happiest retirees achieve adequate income to maintain their lifestyle
• Income investing provides both potential appreciation and reliable income

Conclusion

While index investing may theoretically produce more money in certain scenarios, income-focused investing provides stability and predictability that many retirees value. This episode challenges listeners to consider whether chasing maximum returns is worth the increased risk and uncertainty, especially when approaching retirement.

Transcript

00;00;00;00 - 00;00;54;22
Brandon
You are listening to the Yield to Reason podcast, where we strive to help you build the most important part of your retirement strategy. Because a retirement plan built with robust income sources is a retirement plan built for success. I am Brandon Roberts. This is episode number three. And today we're addressing what I think is probably the biggest argument against adopting an income focused investment plan, an argument disguised as a simple question why do I have more money if I simply invest passively in the S&P 500?

00;00;54;24 - 00;01;32;27
Brandon
It's time to get serious about investment, risk management and the practical use of your money. As we set off on a journey to help you build the retirement you deserve and quite frankly, the one you actually want. So indexed investing or passive indexed investing enjoys the enviable position as what many regard as the ultimate investment choice. Because it's super simple, you just invest your dollars into an index fund or these days, more, more likely an index ETF, and you capture the prosperity of the US stock market.

00;01;32;28 - 00;02;10;28
Brandon
There's really no investing sophistication you need to have, and there is all kinds of historical market data that largely supports the the notion that this is a sure path to prosperity. It is well regarded as a simple plan. Most people can easily implement and be handsomely, handsomely rewarded for doing it. But there are practical breakdowns to this strategy or in this strategy is probably the more correct way to say it.

00;02;11;01 - 00;02;45;11
Brandon
And I would tell you that some of its fiercest supporters, its staunchest proponents, but they have largely been unwilling to admit that these potential breakdowns exist because sometimes a perfectly conceived plan with airtight logic and data to substantiate it. It fails when it's exposed to the variability of real life. And as an aside story here, I have a good friend from college who's an engineer, and he designs components for naval ships.

00;02;45;14 - 00;03;25;25
Brandon
And he's he has complained on numerous occasions. To me that the laborers whose job it is to actually physically put together the things that he draws out, they often fail to follow instructions, as he puts it properly, and they cause problems for what is otherwise a flawless design. That's that's his side of the story. I'm sure if we were to sit down with those laborers and and ask them, they might tell us a completely different story about the engineer's idiotic design and why it doesn't work in practical terms when we're really physically trying to build this thing.

00;03;25;27 - 00;03;54;22
Brandon
That wouldn't be a surprising story. I've I've also met other engineers who often complain about a similar circumstance where we build a really great thing, and then it's handed off to the people who are supposed to actually physically make it. And, they don't. They don't do it. Right. And, I've also met the people whose job it is to, to build these things, who have some choice commentary on the design choices of various engineers and what I'm what I'm getting at here.

00;03;54;22 - 00;04;32;12
Brandon
What I'm saying is that the tactical logic behind index investing has very similar vulnerabilities to it. On paper, it looks pretty good. There are data points that absolutely support what it should be able to accomplish, but in practice, when when things don't always go right, when we don't necessarily know where the the end mark of all this is or what next week, next month, next year is going to possess in terms of of market returns.

00;04;32;14 - 00;05;09;10
Brandon
That's when trying to practice an index style investment or an accumulation focused investment can get a little tricky for people. You start to wonder if you're really going down the right path and there's a whole host of different risks that you face. The most obvious one that a large number of people are aware of. And I would even say pretty willing in most cases to at least theoretically, except in the moment, is the risk of loss experi through a market downturn.

00;05;09;12 - 00;05;39;00
Brandon
So, for example, you have an investment in an indexed style fashion for accumulation. There's a market downturn, and now you have a loss, at least on paper. And and those losses, they can unleash some pretty dramatic psychological harm to a large number of people. And unfortunately, these losses get amplified when very, very good intentioned people make rash decisions in moments of panic.

00;05;39;02 - 00;06;20;08
Brandon
Selling into a down market is one of the surest ways to permanently lose money. We know this. There is loads of historical data that proves this notion. And yet, despite all of the information that is freely available, practically screaming from the mountaintops in various literatures the internet, the radio, the TV, despite all of this information that says it's a bad idea, people do it constantly and they do it because they're not machines and they don't live indefinite lives.

00;06;20;10 - 00;06;55;26
Brandon
Sure. Again, the data supports the notion don't sell into a down market. Wait for the recovery. Things will most likely be fine. There is. There is little evidence to support a theory in in the alternative to that. But but a number of people speak from good amount of experience on this. A number of people look at a declining market, a a bear market, and they start to worry.

00;06;55;28 - 00;07;23;16
Brandon
They start to worry about the timeline of the market. What if the market's timeline doesn't follow my own or this one? The pervasive nagging issue that people have, even in good times. What if this time it's different? When you're selling assets for the sake of retirement income? It really only works as a strategy if assets are continuing to appreciate in value.

00;07;23;19 - 00;07;57;00
Brandon
And while the long term general trend, if we look at historical data, certainly supports that idea. There are smaller periods that tend to be much murkier, much more dubious in terms of what the trend will look like in a meaningful way for me. And we often talk about market declines and their impact on individuals in the context of recoveries.

00;07;57;02 - 00;08;19;03
Brandon
So if we if we live through a bear market or big crash, what what what are we looking at timeline wise to recover our losses? That's something that a number of people are very much interested in trying to discern. The biggest one, the scariest one, the one that I really don't think is going to repeat itself any time soon, was the the crash of the 1930s that led into the Great Depression.

00;08;19;06 - 00;08;39;29
Brandon
It took 25 years to recover from the losses sustained at that point. Now, again, I don't think we're going to go back there. Not trying to tell you that we're headed into any kind of situation similar, but we do have other instances where we saw pretty dramatic market declines, and we can get a sense of recovery periods from those.

00;08;40;01 - 00;09;01;21
Brandon
The two most recent that stand out to most people are the dot.com collapse of the early 2000 period, and then the 2008 Great Recession, as it is commonly called in both of those two cases. It took roughly six years to recover from the losses sustained. If you were in the broader stock market, recovery, keep in mind means that you've just broken even.

00;09;01;21 - 00;09;36;08
Brandon
You've you've clawed back from the losses. And now moving forward, you can start you can start achieving gain. Now think about this scenario. What if what if you're ten years away from retirement and something like the.com crash unfolds? Not the.com crash, but something similar that has a similar reduction in the market with an assumed similar recovery period. Well, now more than half of your remaining working years will be spent just trying to get back to where you were before the big decline.

00;09;36;10 - 00;10;12;15
Brandon
And then you have a few number of years after that to actually achieve meaningful gain in your retirement portfolio. That in that context, makes it an understandably tough sell for being invested in the market. For a 50 something American who is probably running a little thin on patience when it comes to setting an actual retirement date. Now, there is an alternative argument to all of this that is often championed by a lot of, financial advisors, as well as people who are advocates on the internet, for example, for for passive index investing.

00;10;12;15 - 00;10;50;14
Brandon
And that is what if the crash doesn't happen? What if we prosper? What if you end up with tens of thousands of dollars more than you thought you were going to have because you stayed in the market? The crash didn't happen, and we lived through a magnificent period of prosperity. It's an extremely enticing thought, but in my personal experience, chasing that dream tends to trap a good many number of people and cause at least somewhat significant compromised financial health for a number of them.

00;10;50;16 - 00;11;28;11
Brandon
Because. Because timing risk starts to become a bigger issue that everybody faces. Now, the notion of timing risk is something that the foremost individuals, the real concept doesn't come home to for them until they get into retirement. The whole idea here is that annualized market returns can be whatever they are, but the specific time that you need to buy or sell an asset matters, and you are not going to be able to control what's going on in the market at that time.

00;11;28;13 - 00;11;59;24
Brandon
In a very zoomed out, very broad sense, we talk about it in annualized return context. And so we we point out that returns that happen at certain points in your retirement versus other points in your retirement have dramatic consequences to where you will ultimately end up with account balances and overall value of your portfolio. And the industry most commonly refers to this as sequence of returns risk.

00;11;59;26 - 00;12;42;26
Brandon
It notes that you won't have any control over the order in which returns matter, but the actual orders that they take place does have consequences. Will result on what money you can distribute from your portfolio, and what your balances will turn into, possibly even zero if you're not careful. The most common stylized example that's used points out that if if a crash happens early on in retirement, that could much more rapidly expedient the process of reaching zero account balance than if you have a really big boom in the beginning of your retirement, and a crash doesn't happen until, let's say you're ten.

00;12;42;28 - 00;13;08;11
Brandon
So the order of these things, it matters a whole lot. And when it comes to income investing, we don't have to worry near as much about the order of specific returns because they are less impactful on what happens in practical terms of what we can do with our money. I'm not saying there's zero impact. I'm just saying they're less impactful.

00;13;08;14 - 00;13;39;25
Brandon
And let me give you some examples to highlight how this differs between index style accumulation. Investing in income focused investing. We're going to look at a scenario using real historical market data to compare the passive index investing to a more income focused portfolio. So we're going to use the time frame 1999 to 2004. I'm doing this because I want to capture the impact of the.com crash and the Great Recession.

00;13;39;28 - 00;14;13;04
Brandon
Session crash on the portfolio. And we're going to set this up as a $100,000 initial investment amount, with $5,000 a year going into the portfolio. The passive index investment account will we'll use the Vanguard S&P 500 Index Fund Vfi index. I'm not saying that index investing is necessarily doing that. I'm just saying it's a really good analog to evaluate how index investing would, for the most part, unfold under this time.

00;14;13;06 - 00;14;37;09
Brandon
For the income focused account. We're going to use a portfolio of a few different closed end funds, because closed end funds are really good assets for income production. They are assets that we have available historic data on. So we can can plug these into these sorts of scenarios and get a sense of how real investments would have unfolded.

00;14;37;12 - 00;14;59;24
Brandon
So this is not a categorical endorsement on closed end funds, as the way to income invest. It's simply a good way to do it. And it helps that we have plenty of market data that we can use as a side by side comparison to the alternative index investing. And I want to start with this $100,000 amount and then $5,000 to try and replicate a very real life scenario.

00;14;59;24 - 00;15;30;15
Brandon
I have seen happen where people have saved some money and they tend to transition into some other strategy, but they're also going to continue to save money until they retire. So here's here's what these numbers show us. And again, recap 1999 to the year of to year end 2020 $400,000 initial investment lump sum, whatever, $500,000 being contributed annually into the investment plan up until the end of 2024.

00;15;30;18 - 00;15;56;17
Brandon
And for simplicity's sake, I'm just going to assume that $5,000 is invested right the beginning of the year. So, interestingly, the the Accumulation Index investing account obviously starts out as the gate kind of ramping up higher value. But then we run into the dotcom crash and it falls. And it falls well below the account balance of the the income focused portfolio.

00;15;56;19 - 00;16;35;01
Brandon
And it stays below the account balance of the income focused portfolio until 20 and 80. So from basically 2001 until 2018, the account balance of the closed end fund portfolio, the income focused portfolio is higher than the indexed portfolio, the accumulation index portfolio. That's a long time that is going to test the will on the patience of a lot of people if they understand there's this other option available, even if they're purely looking at liquid account balance, which is an income focused world, I don't think you should do.

00;16;35;01 - 00;17;04;12
Brandon
But using that that traditional comparison, the income focused portfolio is doing better, considerably better in a number of years. The income focused portfolio was really not all that drastically effective. In fact, it had great, great periods of time during the dotcom bubble burst, where we had three negative, pretty considerably negative years for the S&P 500. We had three, eight and a half ish percent year returns for the income focused portfolio.

00;17;04;15 - 00;17;28;23
Brandon
It did by comparison, phenomenally. But the 2008 was in for story. They both were hurt in that that case the income portfolio not quite as much as the index portfolio, but it still saw a pretty dramatic decline in values that were, seriously double digits. Now, the time to recover for the income focused portfolio. Far shorter period of time.

00;17;28;23 - 00;17;53;05
Brandon
It was under three years. If we look at the absolute top in 2007 and how long it took to get back there. If we just look at the big, big, big decline in 2008, which took place, kind of at the end of the summer into the fall of 2008, the recovery period for the close and income, portfolio that that took less than a year to get back to, to break even.

00;17;53;08 - 00;18;24;06
Brandon
So the two have performed very, very comparably up to 2018. And in fact, there was a decent gap for a lot of those years that the income focused portfolio was ahead. But then 2018 happens and they kind of pace one another. And then following the 2020, that's that's the period where we start to see the index portfolio really pull ahead.

00;18;24;09 - 00;18;54;15
Brandon
And when we get to the end of 2024, we have a difference in terms of of liquid cash between the two portfolios of just about $385,000. So the indexed investment option does have a cash it in walkaway balance $385,000 roughly. I'm rounding here versus the income focused portfolio. So it's it's at one point $3.5 million accumulated indexed investing.

00;18;54;15 - 00;19;24;01
Brandon
It's just under $983,000 for the income portfolio. So in this case, there's a number of index advocates who would say indexing wins. We have more money. This is better. But think about these these implications or consequences of of how these things have built up over time and and apply them to how individuals would realistically go about using these assets that they've accumulated.

00;19;24;03 - 00;20;08;07
Brandon
The index investment does pay dividends, and those dividends have been reinvested for this entire period of time. So in 2024, the dividends earned for owning via was $15,400, which is nothing but the distributions or dividends paid under the income focused portfolio in 2024 was 104,000. So again, $15,400 in dividends versus $104,000 of income generated by the portfolio. That is a humongous difference.

00;20;08;09 - 00;20;41;18
Brandon
Now, if we were to apply traditional logic, we take our $1.3 million accumulate in the index fund. We retire in 2024. 4% rule tells us income distribution. That's a safe withdrawal rate. Probably never run out of money $54,000 per year. Not bad. But, again, I'll remind you, the portfolio that's focused on income is capable of generating a $104,000 of income in 2024, which means it's most likely capable of producing $104,000 of income in 2025.

00;20;41;20 - 00;21;15;18
Brandon
And every year after that. So if we go the index route, we have more money in terms of what we could liquidate potentially. But now we have the problem of managing the timing of selling shares for the sake of generating cash to go out and live our life. That is an incredibly anxiety inducing activity, has been my experience with individuals who retire.

00;21;15;21 - 00;21;52;12
Brandon
Having followed that style of investment strategy. The income focused approach simply takes the distributions. It's not worried about selling any shares. Now we know what has happened. For basically the first half of 2025, we had tariffs, Liberation Day. We had a dramatic movement in the market down and then back up. We've recovered. That's great. But imagine yourself selling shares in April of 2025 when we have a pretty substantial decline take place in the market.

00;21;52;14 - 00;22;15;20
Brandon
Some people might have just sold the shares, some people might have tried to figure out a way to not sell the shares. There's a whole lot of additional thinking that has to go into what you want to do with respect to using your assets to generate income when you're trying to sell them. And though we did recover, we didn't know that was going to happen back in 2000, back in April.

00;22;15;23 - 00;22;55;28
Brandon
So the volatility creates a significant amount of anxiety and potential problems when you're trying to use the assets for income generation. The distributions on the closed end funds that are in this portfolio that I model, they didn't change throughout the first part of this year. They have not been produced. They they're identical to what they were at the end of 2024, which means if we simply chose to stop reinvesting those distributions and start taking them as income, yes, our account balances probably went down a little bit because share prices and closed end funds, they they've fallen a little bit with the tariff policy and Liberation Day.

00;22;56;03 - 00;23;29;02
Brandon
Not nearly as much as the S&P 500 did, but they did decline in value. So what we just continue to collect distributions and think about a scenario where we really only needed the 50 some thousand dollars that the indexed portfolio can produce for us, that means we have extra money from distributions that we could be reinvesting in a down market, which is one of the best ways to further build up our income producing capacity in an income focused portfolio.

00;23;29;04 - 00;24;03;15
Brandon
So for the most part, we don't really care what's happening with the price of the shares that we own in the income focused portfolio, because they don't matter as much when it comes to the day to day living. In the context of income, we need to live our lives. There may be opportunities. There may have been plenty of opportunities during this entire time frame to sell shares in some of these positions because they had appreciated, and it made sense to move out of one position and into another position.

00;24;03;22 - 00;24;33;28
Brandon
That's been beaten down has a great yield. In fact, next week we'll be having an in-depth conversation with a gentleman who has spent his entire career, which spans almost four decades, teaching people to do that exact thing, specifically with closed end fund. The important point that I want to drive that is the fact that selling the shares for a gain and reinvesting in something that's got a better yield, that's optional, it's not required.

00;24;34;01 - 00;24;59;15
Brandon
And that buys you a lot of time when the market is doing things that are not in your favor, and you still get to live the life that you hoped you could live in retirement and and generate income. When you start to focus your efforts more on income style investment, you don't really fear downturns that much. In some cases, you almost sort of look forward to them.

00;24;59;18 - 00;25;29;00
Brandon
And I remember coming to this realization several years ago, I was investing or looking at at investments in REIT, not so much closed down funds in the specific situation, but I remember looking at a particular REIT and realizing it had something like an 8 to 9% yield and thinking at the time, well, if I just go ahead and buy it with an 8 to 9% yield, if share prices go down, let's say 8%, then with the distributions, I'll be paid at close to break even at that point.

00;25;29;03 - 00;26;09;24
Brandon
So it's good to go more down more than that in order for me to actually lose money on paper. And in that case, if I just hold the position and keep collecting the distributions, I'll probably come out ahead. Even if share prices don't immediately return to my cost basis. That was a very liberating moment for me to realize that I could start acquiring these assets that paid me income, and my intentions were absolutely to reinvest that income, but I had options to to do other things if I wanted to, if if something happened and I needed the income for some other reason, that was that was my choice to do that.

00;26;09;27 - 00;26;42;07
Brandon
That's a bit more liberation in terms of what I'm going to do with my investments than just trying to accumulate and hoping that next year's value will be greater than this year's value. The pursuit of more in just absolute terms, for the simple sake of the pursuit of more is often disastrous. There's a lot of white collar crime that involve stories of people who are never satisfied with their current position in life, and they always needed to strive for more.

00;26;42;09 - 00;27;09;00
Brandon
I'm not saying that if you adopt an indexed accumulation investment style versus an income one, you're necessarily going to go out and become a criminal. That's not what I'm saying. But what I'm pointing out to you is that if you're always trying to grow the account balance bigger just for the sake of a accumulating more money and growing the account balance bigger, you are probably never going to arrive at the point that you think you're striving for.

00;27;09;02 - 00;27;43;24
Brandon
Some of the most astute people I've ever met seem to be individuals who realize that at some point, you you accomplish what you need to accomplish, and you call it quits on taking any more risk. After that. And this is probably one of the major reasons there were a number of folks who were totally okay with cashing out at retirement and just buying CDs, and for sure, some of the happiest retirees I've ever met are the people who figured out how to provide themselves with the income they needed to support the lifestyle they had become accustomed to.

00;27;43;26 - 00;28;16;04
Brandon
And and you realize that some of what I'm saying almost makes it sound like income style investing is, is just a big way of giving up on your on your bigger dreams. And that's really not my intention. I think that from an accumulation standpoint, it can't hold its own against index investing. But I also think there's a point that people can reach in their life where they're capable of producing the income capacity that's necessary for them to get a little lazy about always trying to build the pot bigger.

00;28;16;07 - 00;28;33;01
Brandon
And I really think that there are way too few financial advisors who are willing to admit this. Now we can get off on all kinds of theories as to why that is for the most part, it has to do with compensation structures and fees being charged against balances, and the bigger those balances are, the more money they make.

00;28;33;02 - 00;29;02;16
Brandon
That's fine. I'm not not trying to malign these people for making money. I'm merely pointing out where their incentives lie. To anticipate what their likely behavior is. So will you. In fact, have more money if you adopt an accumulation focused, passive indexed investment strategy? I have no idea. I have looked at this data for years. I have tried to say definitively it will or won't work.

00;29;02;19 - 00;29;39;08
Brandon
And the truth is, the data tells a very mixed story and there's not enough evidence in my mind to say that it's worth all of the risk that it entails. Because if you are trying to accumulate shares or grow the value of those shares with the eventual intention of cashing them in for money that you'll use to live in retirement, you are executing a strategy that needs one specific scenario that has to unfold in order for you to achieve success.

00;29;39;10 - 00;30;04;19
Brandon
Your assets have to continuously appreciate in value, or at the very least, they can't go down. If, on the other hand, you approach this with a strategy that seeks to accumulate income producing investments, appreciation may be part of the play. You may sell shares that have grown in value and capitalize on those opportunities. But it's not the only strategy and the much bigger focus.

00;30;04;22 - 00;30;31;25
Brandon
The the primary goal is the development and the building of income. And when you have that as a backstop, you have substantial more security against market volatility. From the example that I walked through earlier today. If the second half of 2025 ends up with a market that turns back down income, produce from the income portfolio is not really going to change much, if at all.

00;30;31;27 - 00;30;58;26
Brandon
But the ability to produce income from the index portfolio, that is far less clear. And that's a problem when it comes to index style investing. Unfortunately, that's all I have time for today, but have no fears. I'll be back next week with more strategies for you to use to build a rock solid income for your financial independence. If you want even more, please join us on YouTube at Yield to Reason.

00;30;58;28 - 00;31;14;08
Brandon
And until next time, please remember real wealth doesn't just add up. It writes, checks.