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Jul 05th
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Why people avoid index funds

moneylogo_optBY WARREN BOROSON

It’s a mystery.

Although almost anyone with any brains recommends that investors load up on index funds, relatively few investors do. Even Warren Buffett, who has beaten the pants off index funds, has recommended that ordinary investors go the index-fund route.

OK, generally I avoid index funds, too. I do have some exposure, via an annuity, but not much.

What’s the reason?

I’ve heard John Bogle, that great advocate of index funds, say that buying an index fund is like kissing your sister. Boring.

Index funds do have decided advantages:

  • They’re cheap. You’re not paying someone millions of dollars a year to decide whether to buy this or sell that. You’re just tracking a mirror of an investment market, like the Standard & Poor’s 500 Stock Index. So you rarely buy or sell. And as Bogle keeps reminding us, expenses are important.
  • Index funds are well diversified. Well, most of them are. I’ve heard people say that the S&P 500 has the 500 largest stocks. Not true. The goal of S&P’s people is to put together a well diversified portfolio, and S&P people are happy to choose stocks that aren’t among the biggest.
  • They’ve proved themselves. In general, they’ve beaten 80% of actively managed funds. (The 20% that have done better include funds that are index-huggers – that follow an index slavishly except for a few careful tweaks. For example, for a fixed-income index fund, buying corporate bonds rather than Treasuries – because corporates, while slightly riskier, generally pay more.)

Not that it’s impossible to beat index funds. Vanguard’s actively managed funds tend to do better than its index funds. Why? A key reason: They’re also relatively cheap to run.

Still, years ago a Vanguard spokesman told me that in general people should invest 80% in index funds – and 20% in Vanguard’s actively managed funds.


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