“Stock pickers in the U.S. have suffered half a trillion dollars in withdrawals since they
started losing ground to index-tracking funds five years ago. Now, active bond-fund managers are beginning to feel the heat.“
The above quote is from a recent article on Bloomberg titled: Gross Dominance in Jeopardy as Indexing Revolution Engulfs Bonds. The 'Gross' the article refers to is the famous and legendary investor Bill Gross, co-chief investment officer at PIMCO, the world’s largest bond investor. He’s also fund manager for PIMCO’s Total Return Fund, the world’s largest actively managed bond fund with assets of $242.7 billion as of June 30, 2011.
“We’re moving to the second phase of the index revolution. The world is a frightening, uncertain place and investors want to make their portfolios much simpler so they can sleep at night”, so says Peter Fisher, head of fixed-income at Black Rock.
The fact that more and more investors are learning the many benefits index funds offer is great news on many levels. John Bogle, founder of Vanguard, deserves much credit for being a pioneer in this area. Thanks to his and Vanguard's personal mission of leveling the playing field, investors have a more simplified choice when constructing a long-term investment portfolio.
So what is indexing?
Indexing is an investment approach that seeks to track the performance of a specific benchmark, or index. Index funds do this by holding all (or a representative sample) of the securities in the index being tracked. This “passive” investment approach emphasizes broad diversification, limited trading of the securities held in the portfolio, and low costs. In indexing, no bets are made on individual securities.
Why indexing works -
- Index funds, in most cases, are easily understood and as a result simplify the process of investment selection and due diligence. Simplicity and investing, two words you usually don’t see combined very often.
- Index portfolio performance tends to be consistent relative to a benchmark. Being able to reduce uncertainty when developing a comprehensive financial plan greatly increases the odds of long-term financial success.
- Choosing index funds offers an investor style purity. Whether it’s a large cap index fund, small cap, international, emerging markets, etc.; with an index fund you can feel assured that your money is invested as you expected it to be.
- Low cost and low fees are a major benefit of using index funds. With many managed mutual funds charging not only up front commissions but also 1-2% annual fees, compare that to Vanguards S&P 500 Index fund for example which charges an annual fee of 0.17%. Just do the math and you can see what a difference it makes to overall investment performance over the long term. Low cost means more of your money is working for you.
- Tax efficiency tends to be a hallmark of index fund investing. That’s mainly due to the low turnover rate of index funds. Again, similar to high fees, saving money by investing in tax efficient index funds is a smart way to become a tax savvy investor.
Hopefully, this post has sparked your interest in discovering further the many benefits index funds offer investors of all income and net-worth levels. As you do your research, I’d recommend checking out the very well written personal finance book, Personal Finance for Dummies, written by Eric Tyson as well as heading over to the Vanguard website.