This is why we recommend that you stick to index funds

In our index card book, Helaine Olen and I recommend that ordinary investors stick to low-fee index funds–and thus avoid actively-managed mutual funds. Here’s more evidence. In this comparison, only 4.1% of actively-managed funds beat a simple Vanguard index fund over a ten-year period through October 31, 2015. It’s not complicated. It’s just too bad millions of ordinary investors are paying billions of dollars in fees to under-performing investment products.

PS: If professional money managers can’t beat a simple market index, you probably can’t either. So avoid picking individual stocks or other speculative efforts like that. Use your brainpower on your day job, and to be good to people close to you.

Author: Harold Pollack

Harold Pollack is Helen Ross Professor of Social Service Administration at the University of Chicago. He has served on three expert committees of the National Academies of Science. His recent research appears in such journals as Addiction, Journal of the American Medical Association, and American Journal of Public Health. He writes regularly on HIV prevention, crime and drug policy, health reform, and disability policy for American Prospect, tnr.com, and other news outlets. His essay, "Lessons from an Emergency Room Nightmare" was selected for the collection The Best American Medical Writing, 2009. He recently participated, with zero critical acclaim, in the University of Chicago's annual Latke-Hamentaschen debate.

6 thoughts on “This is why we recommend that you stick to index funds”

  1. Idle curiosity–I think of Berkshire Hathaway as an actively managed fund. Do you disagree with that characterization?

    1. Yes and no. Berkshire has certainly produced a phenomenal return on equity, but it has done a number of things that an actively managed mutual fund cannot do. It frequently takes active control of companies, so it has characteristics of a private equity fund rather than a mutual fund. Also, for all that you can listen to Warren Buffett decry the existence of derivatives, Berkshire uses them all the time.

  2. As far as I can tell from the link, it looks like the study avoided one major flaw that sometimes comes up in these comparisons – survivorship bias. Too often these comparisons are done in a backward-looking manner. That is, pick some large number of funds that exist today and see how they did over the past X years. Even that doesn't turn out well for the managed funds, usually, but it also leaves out funds that did so poorly they no longer exist.

  3. One of the rules on your index card is: "Never buy or sell an individual security. The person on the other side of the table knows more than you do about that stuff."

    That's pretty clear and makes a lot of sense. I've got a case that I imagine is an obvious exception to the rule, but I'm not 100% certain because I'm not sure how much lifting the clause "or sell" is doing there. Here's the situation:

    Suppose you've got individual securities that you didn't buy. Maybe you inherited them, or you get them as part of your pay. You might prefer to sell them and get into a low-fee index fund instead, but on a plain reading of the index card that's a violation of the rule.

    Obvious exception to the rule, I'd think? Or am I overlooking something important?

    1. I don't know what Harold thinks, but my answer is, it depends.

      First, is a substantial part of your wealth tied up in the individual security? Then sell. The reward does not justify the risk.

      Second, Is it stock in your employer? Then sell. This is really a corollary to the above. You don't want to be in a situation where your job is at risk because the business does poorly, and your investment goes down for the same reason.

      Third, do you have a large capital gain in the security? If not, and neither of the above applies, consider holding.

      Fourth, do you have other individual securities which, in combination with the one in question, form a reasonably diversified portfolio? Then it's fine to hold. Selling would be a bad idea unless you want to sell the whole pile for some reason.

    2. Some of it depends upon the situation. If it's an inheritance, then, yes, sell the stocks unless there is some strong sentimental value to them. (You should probably do it even if there is such, but that's impossible to quantify.) You are not liable for any capital gains that occurred prior to the inheritance, so there isn't any tax incentive not to sell.

      If you acquired them in some other way, such as a non-inheritance gift or a purchase prior to reading your index card, whether you should sell them is a more complicated question that no one can answer without looking at the specific circumstances.

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