The simple case for index funds is part theory, part
practice, and part arithmetic. Theory says that since
(a) gross returns earned by investors as a group must
equal the gross returns earned by the total stock market,
(b) net returns - after advisory fees and other investment
expenses - earned by investors as a group must fall
short of the returns of the market by the amount of
those costs.
Practice confirms the theory. Returns earned by the
average equity mutual fund in the past have typically
fallen short of the returns on appropriate stock market
indexes by an amount approximately equal to the operating
expenses and transaction costs incurred by the funds.
Over the past 25 years, the average fund has earned
annual returns averaging 11.6% compared to a return
of 13.1% for the Standard & Poor's 500 Stock Index,
a shortfall of 1.5 percentage points per year. In
fact, only 32% of actively managed equity funds have
outpaced this unmanaged index, and no one has ever
suggested a methodology by which those few winners
could have been selected in advance.
And simple arithmetic makes it clear that this difference
is critically important. Over 25 years, a $10,000
investment in the Index would have risen in value
to $217,100, compared to $155,500 in the average fund.
This shortfall - $61,600 - is clearly enormous. For
over time, the miracle of compounding changes a difference
in degree in annual return to a difference in kind
in capital accumulation. Costs matter. That sums up
the simple case for index funds.
Intelligent investors, however, will want more information
about index funds, and you deserve it. Here is where
W. Scott Simon's book enters the picture. Index Mutual
Funds: Profiting from an Investment Revolution presents
the complex case for index funds, an assiduous analysis
of mutual fund past performance and a careful articulation
of how index funds work, followed by a discussion
of the role of index funds in an asset allocation
program and their special cost, risk, and tax characteristics.
I commend his fine book to you, for I believe index
funds have a vital role to play in enhancing the long-term
returns of your investment program.
John C. Bogle, Chairman
The Vanguard Group
of Investment Companies
July 29, 1997
From Index Mutual Funds: Profiting from
an Investment Revolution
Copyright, ©, 1998 by Wendell Scott Simon.
Reprinted by permission. All rights reserved.
See also:
Will Active Mutual
Funds Continue To Underperform The Market In The Future?
Testimonials To
Indexing From Leading Investment Experts
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