Earn Above-Average Returns With Index Funds
March 24th, 2008 |Practically everybody attempts to beat the market at some point in their investing career. Sadly, only a tiny minority will succeed. Even worse for most, the very act of trying to beat the market virtually guarantees they will under-perform due to the drag of transaction costs and taxes. Stock picking rarely works, market timing is even less effective, and momentum investing is nothing more than gambling.
But what if I told you there was a way for you to earn above-average returns with virtually no effort? It’s possible, but it’s probably not what you think: index funds. No, that wasn’t a typo. Most people are under the false impression that investing in index funds is settling for average performance when nothing could be further from the truth. In fact, index funds must mathematically earn above-average returns over time.
To most, the concept that the average market return could in fact be above-average is counter-intuitive. How could this be? Well, it’s simple. For starters, it’s widely reported that 80% of mutual funds fail to beat the market and this should be your first clue but it’s actually much simpler than that. Consider that the return of the actual un-managed index (the index itself, not the fund tracking it) is the average weighted return of every investor in the market, large and small. Now consider that the average INVESTOR’S return is simply the return of the un-managed index minus the transaction costs and other expenses required to get that return.
So far so good. As you may know, index funds are by far the cheapest type of mutual fund to own because there is no need to hire expensive analysts to do stock research. Therefore, since the average investor earns the return of the index minus expenses, anybody with below-average expenses has an enormous advantage versus those with above-average expenses. And if those investors own index funds, they are mathematically guaranteed to earn at least in the top 50th percentile since there is no tracking error with index funds: the return you get is merely the index minus the fund’s tiny expense ratio.
And there you have it: invest in index funds and you will beat most of the competition, if not the market.
Visit http://amateurassetallocator.com for more on investing, saving money, personal finance, and the economy. Make sure you subscribe to the RSS feed to receive Personal Finance and Investing information from the convenience of your favorite RSS Aggregator.
Useful Links:
An online income calculator is an ideal way to track your outgoings and plan budgets. Personal finance management and clever budgeting is key to reducing your monthly expenditure.
