Why would creating your own index fund with only high quality companies (founder led, high employee/customer satisfaction, etc.) underperform the S&P 500 over the long run?

I often write on Quora.com, where I am the most viewed writer on financial matters, with over 252.5 million views in recent years.

In the answers below I focused on the following topics:

  • Why would creating your own index fund with only high quality companies (founder led, high employee/customer satisfaction, etc.) underperform the S&P 500 over the long run?
  • What are the pros and cons of living in Shanghai as a European expat with a family? I go over some of the more unexpected pros and cons alongside the obvious ones.
  • What is the best city to live in Asia for Western people?
  • What is the best Index Fund that pays dividends, if such a thing exists in reality.

Some of the links and videos referred to might only be available on the original answers.

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Why would creating your own index fund with only high quality companies (founder led, high employee/customer satisfaction, etc.) underperform the S&P 500 over the long run?

Firstly, this has already been done. Many indexes have been created to tilt towards small caps, growth, dividends etc.

Take Dimensional Fund Advisors who tilt towards smaller cap stocks:

Or O Shares ETFs

There are many kinds of “Smart Beta” ETFs, which in human terms means the ETF that uses a rules-based system for selecting investments to be included in the fund portfolio.

In comparison, the traditional index fund just holds the needle, and not the stack.

Right now, the evidence is unclear. Will Dimensional Funds beat Vanguard long-term? It is difficult to know.

The average Dimensional Fund Advisor client does tend to get better returns, but that is because they only go through advisors.

Clients that go through advisors, even on Vanguard according to their “advisors alpha series”, get better returns, due to having somebody who can whisper in their ear during those difficult moments not to panic sell.

The actual funds themselves haven’t outperformed so far, just the average client has, but that could change in the future.

If you created your own, rather than go into a smart-BETA ETF, it probably wouldn’t work, for the following reasons:

  • The costs would be too high to create it, due to transaction costs
  • It would take too much time to rebalance every year
  • Your bias’ would influence the selection of stocks in the index.
  • A few extreme losing stocks, or one awful year, could drag down the average performance. In a normal index, the big losers (like Lehman in 2007–2008), are “cleaned” from the index. If you hold individual stocks, you would need to take that loss.
  • If you beat the index for say ten years you might relax and fail to do things like rebalance the “index”. That complacency could hurt the portfolio.
  • Holding many individual stocks wouldn’t even be an index to begin with.
  • Basically human error full stop. The longer you try it, the more likely this issue will flare up.

So, I would stick to more traditional products.

What are the pros and cons of living in Shanghai as a European expat with a family?

The pros and cons will depend on your personality, what you want to achieve, the industry you work in and many other factors.

It will also depend on whether your motivations are financial, to get an experience or something else.

The pros

  • You will learn a lot. For all the faults, there are many smart business people in China.
  • Even though Shanghai is more developed than before, and the growth rates in general in China are probably exaggerated (than the official figures), you will feel a sense of progress if you regularly visit some of the outskirts areas. That sense of change is exciting.
  • Expat packages are still big in some industries, and there is money to be made if you run your own business of course.
  • The food culture is great. It is the one place in the Mainland where you can get whatever you want. Sure, places like Beijing have many foreign and local cuisines. But Shanghai has every possible niche.
  • The easiest city in Mainland China to live as an expat.
  • There are a lot of things to do as a family compared to even most European cities. Talking from a UK perspective, only London could compete with the sheer quantity of opportunities.

The cons

  • Taxes are high in China if you are earning decent money. If you add up the cost of living + the taxes, the “total” cost of living can be higher than Singapore or even Monaco. You pay zero taxes in the UAE or Monaco in most situations unless you are American or another country that taxes by citizenship. Singapore taxes 0% on overseas sourced income, and locally sourced income isn’t overly taxes.
  • It isn’t as clean or orderly as a place like Japan, Singapore or even South Korea.
  • Safety isn’t great on all measures. Safety from violent crime is very good – almost as good as some of the aforementioned countries in Asia. It is, statistically speaking, worse than some European countries like Switzerland or Finland, better than others and probably average overall, but better than the US. Yet if you include safety from food, drink and pollution, alongside the political environment, it isn’t great overall. Your chances of drinking fake alcohol, or very toxic food, or being detained if you are a foreign journalist are higher than many countries.
  • The attitude towards foreigners is better in Shanghai than some other places in China, but is more hostile than 10–15 years ago. It isn’t the friendliest place in the world, by any means, these days.
  • Life can be more inconvenient as an expat. We all know about needing to use VPNs to use Facebook, YouTube or indeed now Quora. However, what fewer people know is how difficult it is to just serve the internet. If you go onto a website which is foreign, it slows down the internet connection. Whenever I go to China, I often need to delay making international calls or doing some business activities due to the internet situation. Running an online business from China is much more difficult than some countries despite the fast internet, due to this issue.
  • Following on from the last point, getting money out of China can be difficult. Technically speaking, and according to the rules, it should be easy, but in reality it isn’t. There are also restrictions on sending money to accounts which aren’t in your own name. That means sending money to family members or some forms of investment accounts (because many investment providers’ bank accounts are in the company name, and you need to put your name and account number in the comments or reference section) is difficult. At least if your employer agrees to pay you through Hong Kong, or another offshore location, this point will be easier.
  • The rules can change very quickly when it comes to expat visas.
  • The climate gets pretty cold in the winter and hot in summer. Hong Kong is better (from a personal preference perspective) from that point of view.
  • Bosses. If you need to work for somebody else and that person is local, most expats report that there can be a “little Mao” problem. In other words, authoritarian bosses who treat their staff like kids. For example, needing to punch in and out when you arrive for work, and being fined for even being a few minutes late. In MNCs though, this is better, especially if there is Western management.
  • It isn’t cheap for quality. Sure, the basics are very cheap, like the subway/metro system. Quality isn’t.
  • You are coming to a one party state. That is the bottom line and that explains some of the points above.

Despite all the positives and negatives, few people regret having one stint in China as an expat.

What is the best city to live in Asia for Western people?

That depends on many things, such as your preferences, industry and so on.

I will come off the fence though and suggest:

  • Singapore for most, but not all, corporate careers and if you are high-net-worth
  • Malaysia for a “Singapore-lite” experience. Some of the same benefits but cheaper.
  • For location-independent people like online business owners, digital nomads and retirees, Malaysia or Thailand. Malaysia is better if language is important for you
  • Some parts of Cambodia, Vietnam and some smaller Chinese cities if you want the best bang for your buck.
  • If you want relatively decent prices (but not super low) AND quality, I would pick Kuala Lumpur, some parts of Thailand and South Korea and Taiwan.
  • Singapore, Japan, Taiwan or South Korea for safety, order and politeness.
  • Shenzhen (China) for tech workers. For learning about business in general, China is good. You will learn things in China, regardless of whether you like it or not. I imagine India is good as a business experience, but I have only visited once, so I can’t comment.
  • Smaller cities in general for “an experience”, especially in the mid-income and poorer countries.
  • Cambodia for ease of opening a fully owned local business. Many countries have restricted on this. For business openness, Cambodia, Hong Kong and Singapore are probably best.
  • Singapore, Philippines and Malaysia for English.
  • Most surprising location – probably Indonesia. Jakarta would be a decent place to live if the traffic wasn’t so awful.
  • For ease of visas Cambodia is difficult to beat.

Also depends on where you want to close the border. If you want to include the Middle Eastern part of Asia, the UAE (especially Dubai) is a decent candidate for business people.

For me the most underrated places are South Korea and especially Kuala Lumpur (Malaysia) and Taipei (Taiwan).

People who haven’t visited often assume, wrongly, that Malaysia is a very strict religious country and that impacts expats, which isn’t true.

Taiwan gets overlooked compared to Japan and China.

What is the best Index Fund that pays dividends?

If you want indexes that pay the highest dividends that you can buy a fund which tracks high-paying dividend stocks around the world.

However, that isn’t always the best strategy. When a company pays a dividends, they are taking money out of the business.

Some of the best performing stocks in the last twenty years don’t pay any dividends, or pay low amounts of money out to shareholders.

Instead, the money is reinvested to grow the business. Amazon and many tech companies are examples of this.

For most people, it makes sense to own three indexes:

  • A home country index
  • An International one
  • A bond market one

For example, FTSE All Stars, total international market excluding the UK and a UK bond index if you are a British investor.

Right now, the FTSE100 is one of the best paying indexes from a dividend point of view, and the CAPE ratio makes it look undervalued, but you will be taking your own risks if you are a non-British investor like currency devaluations.

It is better to own both growth and value, which will give you a percentage of dividends.

Come retirement, just withdraw a safe amount, as opposed to focusing on the highest possible dividend.

Pained by financial indecision? Want to invest with Adam?

Financial Planner - Adam Fayed

Adam is an internationally recognised author on financial matters, with over 252.5 million answers views on Quora.com and a widely sold book on Amazon

Further Reading 

In the answer below, taken from my online Quora.com answers, I spoke about the following issues and topics:

  • Do I think it’s possible to be successful financially after 30 without saving much? I explain why saving and investing is essential.
  • Some people assume that you can make investing your job in your 20s. I explain why this is a silly idea for most people, even though investing from your salary is a great idea.
  • Will Joe Biden’s tax plans have unexpected consequences?

To read more click on the link below.

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