Indexfundfan\’s blog (new URL is Indextown.com)

August 25, 2006

Taylor’s great indexing post

Filed under: Investing — indexfundfan @ 1:36 pm

Once in a while, investors need to be reminded why index funds are the preferred choice for long term investments. I came across one of the many great posts made by Taylor in the Diehards forum recently. The one below, reproduced from post 52553, messages 7 through 9, stands out as one of the best post on the benefits of indexing:

1. Index funds (on average) have higher returns than managed funds. (play the odds).

2. Diversification: The increased diversification of index funds results in lower risk. Baer & Ginsler did a study of Standard Deviaton for actively managed funds vs. the total stock market over both 5 and 10-year periods. Their conclusion: “The returns of actively managed funds were 20 to 25% more volatile than the broad market.”

3. Consistancy: Vanguard’s Total Stock Market Index Fund ranked among the top 25% of large-blend funds in just two of the past 10 years. Nevertheless, because of it’s consistency, only twice falling below average, it outpaced 85% of all large-blend stocks after taxes.

4. Continuation: Of 355 actively managed equity mutual funds around in 1974, less than half survive today. Indexers do not have to worry that their fund will disappear.

5. No style drift: We know that asset allocation determines about 90% of portfolio performance. Managed fund allocations often change.

6. No overlap. It is almost inevitable that a portfolio of managed funds will have overlap. This is not a problem with index funds.

7. No manager changes: History tells us that the average manager leaves within five years. Index fund investors do not worry about manager changes.

8. No worry about underperforming a benchmark index: Many current best performing managed funds later seriously underperform (U.S. Growth, Magellan, Legg Mason Value Trust, etc.). It is much more important to avoid losses than to achieve extra gains.

9. No worry about “asset bloat” which often causes large successful funds to underperform (Magellan).

10. Less cash dilution. Index funds hold less cash than active funds.

11. Less worry that a manager has “lost his touch.” Index funds are expected to return to profitability.

12. Tax-Efficiency: Index funds are significantly more tax-efficient than most managed funds. It is after-tax return that counts.

13. Low maintenance: Index funds are simple, predictible, and easy to understand, explain, and maintain.

14. Peace of mind: Indexers know the averages are always working for them. The index investor has much less worry and more free time to spend with family and other more enjoyable endeavors.

Testimonials to indexing from leading investment experts:

“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees.” Warren Buffet

“Most investors would be better off in an index fund.” Peter Lynch

“Only about one out of every four equity funds outperforms the stock market. That’s why I’m a firm believer in the power of indexing.” Charles Schwab

“Index funds are perhaps the most underrated stock funds in existence.” “Mutual Funds for Dummies”

“The fund industry’s dirty little secret: most actively managed funds never do as well as their benchmark.” Arthur Levitt, Chairman, SEC

“The closest thing to a sure thing is that the Wilshire 5000 index will outperform actively-managed funds by l.5 to 2 percentage points a year over a sustained period.” Jack Bogle

“Over the long-term the superiority of indexing is a mathematical certainty.” Jason Zweig, senior writer for “Money”

“The media focuses on the temporarily winning active funds that score the more spectacular bull’s eyes, not index funds that score every year and accumulate less flashy, but ultimately winning, scores.” W. Scott Simon, author

“I love index funds.” William Sharpe, Nobel Laurete

“Indexing is for winners only.” Jane Bryant Quinn, author, syndicated columnist

“The most efficient way to diversify a stock portfolio is with a low fee index fund.” Paul Samuelson, Nobel Laurete

“Most people should simply have index funds so they can keep their fees low and their taxes down.” Jack Meyer, CEO, Harvard Management

“Four years ago I was a fan of index funds. Today I am a true believer.” Jonathan Clements, senior writer, Wall Street Journal

“We find that on average, active management reduces a portfolio’s returns and increases its volatility compared with a static index.” Vanguard Investment Counseling & Research Analysis

“They’re just not going to do it (beat the market). It’s just not going to happen. Daniel Kahneman, Nobel Laureate

“I was not always an obnoxious indexing zealot. Ten years of believing in and selling active management strategies in the brokerage industry made me this way.” Rick Ferri, CFA, author, financial adviser

“Active portfolio management thus tends to generate lower returns and higher taxes.” John Haslem, author, “Mutual Funds: Risk and Performance Analysis”

“Indexing virtually guarantees you superior performance. Bill Bernstein, author, financial adviser

“Index funds save on management and marketing expenses, reduce transacton costs, defer capital gain, and control risk — and in the process beat the vast majority of actively managed mutual funds.” Good & Hermansen, authors

“In every asset class where they are available. Index! Four of five funds will fail to meet or beat an appropriate index.” Frank Armstrong, author, financial adviser

“With an index fund–the certainty of keeping up with the market is a very worthwhile trade-off for the possibility of beating it.” Jack Brennan, CEO Vanguard

“Searching through a list of 234 domestic equity funds that have survived for 20 years, only 31 did better than the Vanguard 500 Index. That means the odds are really, really poor that any of us will do better than a low-cost broad index fund.” Scott Burns, syndicated columnist

“Choosing actively managed funds is the triumph of hope over reason and experience.” Larry Swedroe, author, financial adviser

“It’s just not true that you can’t beat the market. Every year about one-third do it. Of course, each year it is a different group.” Robert Stovall, investment manager

“Giving up the futile pursuit of beating the market is the surest way to increase your investment efficiency and enhance your financial peace of mind.” Ron Ross, author and adviser

“It is basically impossible to beat the market.” Prof. Eugene Fama

“Indexing is a marvelous technique, I wasn’t a true believer, I was just an ignoramus. Now I am a convert. Indexing is an extraordinarily sophisticated thing to do.” Douglas Dial, former CREF portfolio manager

“Simple buy-and-hold index investing is one of the best, most efficient ways to grow your money.” Michael Lebouf, Ph.D., author

“The best plan for most of us, is to commit to buying some index fundss and do nothing else.” Charles Ellis, author

“With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me.” Bill Miller, portfolio manager

“We should just forget about choosing fund managers and settle for index funds to mimic the market.” Pat Regnier, former Morningstar analyst

“Because active and passive returns are equal before cost, and because active managers bear greater cost, it follows that the after-cost return from active management MUST be lower than that from passive management.” William Sharpe, Nobel Laurete

“The most efficient way to diversify a stock portfolio is with a low fee index fund.” Paul Samuelson, Nobel Laurete

“We find that on average, active management reduces a portfolio’s returns and increases its volatility compared with a static index implementation of the portfolio’s asset allocation policy.” Vanguard study

“Buy and hold. Diversify. Put your money in Index Funds.” Justin Fox, Fortune senior writer

“Index funds save on management and marketing expenses, reduce transaction costs, defer capital-gain, and control risk–and in the process, beat the vast majority of actively manage mutual funds.” Good & Hermansen, authors

“You should switch all your investment in stocks to index funds as soon as possible, after giving proper consideration to any tax consequences.” Chandan Sengupta, author

“I am somewhat skeptical about anyone’s ability to consistently beat the market.” Moshe Milevsky, author

“With an index fund–the certainty of keeping up with the market is a very worthwhile trade-off for the possibility of beating it.” Jack Brennan, Vanguard CEO

“With a very simple and basic understanding of index funds, you can consistently beat 70% to 80% of all professionally managed index funds.” Tweddell & Pierce, authors

“Invest in a stock index mutual fund. What a brilliant, ingenious, common sense idea that I can’t take credit for, but can religiously pass along to those of you who want to unclutter your financial lives and own a sophisticated portfolio.” Bill Schultheis, author

“For most of us, trying to beat the market leads to disastrous results.” Prof. Jeremy Siegel, author

“The surest way to make money in the stock market is not to work very hard at it. Don’t try to outsmart the market; settle for matching it. Put most of your money in an index mutual fund.” Gary Belsky, author

“Most investors should simply invest in index funds.” Robert Rubin, Secretary of the Treasury

“My strongest commitment in the mutual fund arena is to index funds.” Richard Young, editor

“I recommend that the long-term buy-and-hold portion of your equity portfolio be invested in equity mutual funds.” Sheldon Jacobs, author

“The smartest thing people can do if they want money in the equities market is buy an index fund that is run for 30 basis points a year and forget about it.” Elliot Spitzer, NY Attorney General

“The only consistent superior performer is the market itself and the only way to capture the superior consistency is to invest in a properly diversified portfolio of index funds.” Rex Sinquefield, researcher

“It’s extremely difficult to beat the market.” Peter Brimlow, Forbes senior editor

“There can be no question that indexing for most categories of taxable invesor and for most marketable conditions, will outperform conventional active management.” Robert Arnott, CEO First Quadrant

“A passive index fund managed by a not-for-profit investment management organization represents the combination most likely to satisfy investor aspirations.” David Swensen, author

“The S&P index benchmarks outperformed their active peer funds in all nine Morningstar style boxes over the past ten years.” Gus Sauter (1-25-05)

Additional articles of interest:

“The Index Fund Moves from Heresy to Dogma”

S&P Indices Versus Active Funds Scorecard

The Arithmetic of Active Management

The Difficulty of Selecting Superior Mutual Fund Performance

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