Passively Managed Funds (Index Funds)

An important alternative to actively managed funds is passively managed funds, index funds . Because of their importance in our discussion throughout this book, I emphasize the definition.

Insights

An index fund seeks to match a particular market index, such as the S&P 500 Composite Index, at minimum expense. It is an unmanaged portfolio, requiring only those changes necessary to keep it matched to its underlying index. For example, Vanguard's Index 500 Fund, one of the two largest mutual funds in the country, is designed solely to track and match the performance of the S&P 500 Index, arguably the best measure of general stock market performance, and the market measure used by most professional investors.

Because no security analysis, research, and complex decision making is involved in running index funds, they typically have very low expense ratios. The first equity index fund was established by Vanguard in 1976, so there now is a record about index funds extending for more than 25 years .

One of the critical issues all intelligent investors must eventually answer is whether they really are better off in the long run pursuing various actively managed funds, or whether they can achieve more success by simply holding an index fund. This issue is addressed throughout the book, and I show how index funds are almost always going to win the mutual fund race. Within the mutual fund business, index funds present a strong case against actively managed funds for the average investor who invests for long periods of time.