Why Index Funds?

Index Investing: Your Best Bet for Long-Term Success

You may be familiar with index investing – attempting to match a market’s performance by investing in a fund that tracks a representative sample of that market. Mutual fund companies, stock brokers and private money managers are constantly promising investors that they have some special talent that will translate into market-beating returns and spectacular financial success. Unfortunately, these claims are equivalent to the promises of riches offered by a state lottery or a Las Vegas casino. It’s nice to dream, but the odds are decidedly against you. Index investors happily settle for whatever the markets bring them, confident that in the long-run, the odds are in their favor.

Historically, there are very few money managers (professional or amateur) with documented success in beating their benchmark index over extended periods of time. In fact, as the time measured increases, the number of funds with superior after-cost performance dwindles. The result of this fact is that the odds of actively managing an investment portfolio that outperforms a passive index fund over the long-term (say, 10 years or more) are relatively low. And, like the lottery, it’s impossible to know in advance which ticket will win the payoff. To complete the previous analogy, trying to beat the markets might be fun, but it’s like betting against the house in a casino. You might get lucky in the short run, but in the end, the odds will catch up with you.

Why is it that some of the best and brightest minds in investing can’t outwit the market in which they invest? Well, actually, some of them can, but not by enough. Even when they do perform well, the added value is usually not enough to overcome the high costs they incur in their efforts (much of which is their compensation). The costs of investment management directly reduce your investment return and active management typically costs much more than index investing. And, this handicap can result in a much smaller portfolio ten or twenty years down the road.

So, if you’re investment portfolio consists of a complex mix of actively managed securities, I urge you to consider the advantages offered by a properly constructed portfolio of index funds. Not only will it be simpler and less expensive to manage, but it will shift the odds of long-term success decisively in your favor.