Average Highfliers Forget the naysayers. Index funds rule.
(FORTUNE Small Business) – You know all those magazine covers screaming "Seven Stocks to Buy Now"? All those pundits and gurus who say mutual fund investing is dead? They make stock investing sound like a cross between heat-wave thermodynamics and medieval theology. Ignore them. Ignore the stock market too. Just invest in a good, cheap index fund, and pay no further attention.
You've probably heard of index funds, because the secret is out: Most mutual funds can't beat market averages, and the averages are just what you get from an index fund. But you're likely to hear more about indexing soon because of a revolution brewing in the mutual fund industry.
Once wedded to active management (and star managers), mutual fund companies nowadays are cranking up their index offerings, even if some of them hold their noses doing so. Fidelity Investments, for instance, is pushing its new Four-in-One fund, which combines four Fidelity index funds to offer a single portfolio solution. Barclays PLC, the world's leading index fund manager, caters to institutions but now plans some index offerings aimed at individual investors. And on the Internet, E-Trade is offering six index funds, while startup company Stockjungle.com is offering a free index fund.
None of this should be surprising, given that about 40% of the money (net of redemptions) flowing into stock mutual funds last year was being indexed.
For the uninitiated, indexing is the soul of simplicity. Instead of using high-priced fund managers and exhaustive research, index funds merely strive to mimic the performance of a given index, such as the Standard & Poor's 500, by holding the same stocks in the same proportions. That means rock-bottom expenses--about one percentage point less than with regular stock funds.
According to Princeton University economist Burton Malkiel, while global index funds have had a spotty record, domestic broad-market index funds regularly outperform about two-thirds of all actively managed mutual funds. As he points out, the Standard & Poor's 500, in fact, beat nine of ten active managers in the past decade. Over the past 30 years, a $10,000 investment in the index would have grown to $311,000 (after expenses), vs. $171,950 in a general equity fund.
If you think about it, it makes sense that most of us can't beat the indexes. They have no real cost of doing business, and they define the average for the rest of us (who are collectively average by definition).
Indexing is really just a sly way of riding along for free on the costly investment decisions made by others. That's why the strategy is gaining popularity. As of Oct. 31, according to Financial Research Corp., a Boston consultancy, index funds accounted for 9% of stock fund assets, up from just 2.8% in 1992. The number of these funds is growing too: At last count, there were 133.
If you really want the simplest approach possible to achieving optimal returns, first decide how much you want to invest in stocks. Then put that amount into the Vanguard Total Stock Market index fund, which adheres to the broadest market index, the Wilshire 5000. The fund is weighted toward larger multinational companies, so you even get a kind of foreign exposure as well.
Then, instead of poring over mutual fund data, you can spend your time contemplating how you'll spend the added returns your index fund is likely to deliver. Now doesn't that sound like fun?