Why Index Funds Have Greatly Increased in Popularity

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The stock market is an extremely popular place for people to put their savings. In the long run, stocks have outperformed both bonds and savings accounts. But many people don’t want the complication of owning individual stocks. Instead, they purchase mutual funds. These funds pool the money of many investors. In this way investors are able to get the diversity and stability they crave without putting in millions of dollars into the stock market.

However, there has been a very big trend in recent years – the growth of index funds. Instead of hiring the best talent available and try to outperform their benchmarks, they merely try to beat them. What has caused this?

Many “hot funds” don’t stay hot for long. For example, during the tech bubble, growth funds heavy in technology did extremely well. It was not unusual for funds to give high double digit returns every year. Of course, once the dot com stocks crashed the funds went along with them. Fund managers find it very difficult to outperform the market in the long run. Some years they might beat the benchmark handily. But this is usually done by overloading in a sector, and once this type of stock falls backs to earth the fund crashes. So much of this so-called financial “wizardy” is merely due to cycles.

If you look at performance in the long run (longer than 10 years), you will find that very few mutual funds outperform their benchmarks. In fact, they will actually under perform them because of their fees. This is why index funds have become so popular. Investors have realized that its almost impossible to beat the market in the long run and have instead focused on keeping their costs low.

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Source by Alex Villanueva