In 1975, John Bogle, the founder of Vanguard, introduced the world’s first index fund. These simple funds buy stocks and match the market (more precisely, to match an “index” of the market, such as the S&P 500), versus the traditional mutual fund, which employs an expensive staff of “experts” who try to predict which stocks will perform well, trade frequently, incur taxes in the process, and charge you fees. In short, they charge you to lose.
Index Funds: “If you can’t beat ’em, join ’em”
Index funds set a lower bar: No experts. No attempts to beat the market. Just a computer that automatically attempts to match the index and keep costs low for you. Index funds are the financial equivalent of “If you can’t beat ’em , join ’em.” And they do so while also being low cost and tax efficient and requiring hardly any maintenance at all. In other words, index funds are simply collections of stocks that computers manage in an effort to match the index of the market . There are index funds for the S&P 500, for Asia-Pacific funds, for real estate funds, and for anything else you can imagine. Just like mutual funds, they have ticker symbols (such as VFINX).
Bogle argued that index funds would offer better performance to individual investors. Active mutual fund managers could not typically beat the market, yet they charged investors unnecessary fees.
Illusory Superiority and Wall Street
There’s a funny effect called illusory superiority, which refers to how we all think we’re better than other people (especially Americans). For example, in one study, 93 percent of respondents rated themselves in the top 50 percent of driver skills—an Obviously impossible number. We believe we have a better memory, and that we’re kinder and more popular and more unbiased than others. It feels good to believe it! Yet psychology has shown us that we are flawed.
Once you understand this, Wall Street makes a lot more sense: Every mutual…