Are index funds the best investment?

Three piggy banks in the sky

For 35 years, Bay Area finance revolutionaries have been pushing a personal investing strategy that brokers despise and hope you ignore. [This is] the story of a rebellion that's slowly but surely putting money into the pockets of millions of Americans, winning powerful converts, and making money managers from California Street to Wall Street squirm.

So writes Mark Dowie in a recent issue of San Francisco magazine. Dowie describes how Google prepared for its IPO in 2004. Aware that hundreds of young employees would soon be millionaires, the company brought in a series of financial experts to teach them to make smart investment choices.

  • Stanford University's Bill Sharpe, winner of the 1990 Nobel Prize in economics said, “Don't try to beat the market.” He advised the Google employees to put their money into indexed mutual funds.
  • Burton Malkiel, author of the classic A Random Walk Down Wall Street (in which he posits that a “blindfolded monkey” could pick stocks as well as a professional money manager) and former dean of the Yale School of Management said much the same thing. “Don't try to beat the market … and don't believe anyone who tells you they can — not a stock broker, a friend with a hot stock tip, or a financial magazine article touting the latest mutual fund.”
  • Jack Bogle is the founder and retired chairman of The Vanguard Group. What did this expert on mutual funds advise? The same as the others. “Brokers and financial advisors … are there for one reason and one reason only — to take your money through exorbitant fees and transaction costs, many of which will be hidden from your view.”

These experts, and many like them, recommend the same thing: take the slow, sure path to wealth. Invest your money in index funds. Index funds are low-maintenance, low-cost mutual funds designed to follow the price fluctuations of a broader index, such as the Dow Jones Industrials or the S&P 500. They are boring investments. But they work.

Related >> How to Invest in Index Funds

Jack Bogle's common-sense approach has inspired a loyal following among savvy investors, many of whom participate in the Vanguard Diehards discussion forum.

[This] forum is characterized by its contributors' commitment to low cost — primarily index — mutual fund investing, its unusually civil tone, and the thoughtful replies to almost all who post a question, no matter what their level of investing knowledge.

Some of these diehards call themselves Bogleheads in tribute to their muse. Three of them recently published The Bogleheads' Guide to Investing, which is an excellent guide to smart investment choices. In the book, the Bogleheads stress their philosophy: Make index funds the core — or all — of your portfolio.

But not everyone believes that index funds the best choice for personal investors. A week ago I shared a brief conversation about money with Sparky, a friend to whom I often go for investment advice — he reads widely on the subject, and is well-informed. He doesn't like index funds. Also last week, Jim at Blueprint for Financial Prosperity urged his readers, “Don't just buy index funds.” Another blogger is worried that even index funds may be getting too complicated.

Even some professionals prefer other stock investment strategies. For example, Lowell Miller wrote a well-regarded book entitled The Single Best Investment: Creating Wealth with Dividend Growth in which he touts high-quality, moderate-growth, dividend-producing stocks as the best choice. In The Only Investment Guide You'll Ever Need, Andrew Tobias admits the virtues of index funds, noting that over time they beat the returns on nearly every other sort of investment. But he notes:

For the prudent, thoughtful investor there is now the possibility of the ultimate fund. The one you put together yourself. The Personal Fund. It is no-load, of course, because you don't charge yourself a nickel. And not just low-expense, like an index fund, but, rather, no expense.

This “personal fund” approach is exactly what my friend Sparky was trying to describe to me in our conversation last week. I like the idea of using some portion of my portfolio for a personal mutual fund. It's easier for me to pay attention to my investments when they're stocks I picked myself. But I will always want the core of my investments to be in index funds.

Despite the dissenters, most experts agree: index funds are an excellent way to get rich slowly. Dowie's article on the subject is long, but is worth reading if you're serious about your stock investments. Bookmark it. Print it. Save it for later. But make some time to read it.

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