Burton Malkiel is a hero to The Biz Bucks Guy. His 1973 book, A Random Walk on Wall Street is a classic and spawned the index fund industry. Together with John Bogle, founder of index-purveyor Vanguard, Malkiel has saved millions for millions.
Simply put, Malkiel’s thesis is “we are better off riding the market than trying to beat it.” Index funds are passive mutual funds that simply track a market index such as the S&P 500 or the Wilshire 5000. The most important point is this: index funds are cheap, meaning the amount of administrative fees you pay is minor compared to actively managed funds. But you may ask, “Don’t I get better returns from active managed funds?”. The short answer is “Nope!” In the Wall Street Journal article “You’re Paying Too Much for Investment Help”, Malkiel updates the data.
Index funds, each year, beat the performance of about two-thirds of the active fund managers. OK, so try to find the other one-third, you might say. There is a problem. Most of the other one third only outperform the market for one year, then they fall back into the two thirds. Over a five year period ALMOST NO ACTIVE MANAGED FUND BEATS THE MARKET ITSELF. And you, you Warren Buffet Wannabee, have paid some three to five times the administrative fees for this lack of performance.
Do these administrative fees add up? You bet. If a fund advertises they ONLY take 3% of your assets to actively manage your portfolio, consider this. In a good year, you might make 7%. That means you net out about 4% for an actively managed fund. With an index portfolio, these passive funds will allow to keep about 6.8%. Do the compounding of that difference for ten years and see how you feel!
Malkiel’s op-ed piece concludes, “The lesson for investors is very clear: You can’t control what markets can do, but you can control the costs you pay. The less you pay to the purveyors of investment services, the more there will be for you. The quintessential low-cost investment vehicles are index funds, which should comprise the core of every investment portfolio. The high fees charged for active management cannot be justified.”