John C. Bogle
The simple case for index funds is part theory, part practice, and part arithmetic. Theory says that since (a) gross returns earned by investors as a group must equal the gross returns earned by the total stock market, (b) net returns - after advisory fees and other investment expenses - earned by investors as a group must fall short of the returns of the market by the amount of those costs.
Practice confirms the theory. Returns earned by the average equity mutual fund in the past have typically fallen short of the returns on appropriate stock market indexes by an amount approximately equal to the operating expenses and transaction costs incurred by the funds. Over the past 25 years, the average fund has earned annual returns averaging 11.6% compared to a return of 13.1% for the Standard & Poor's 500 Stock Index, a shortfall of 1.5 percentage points per year. In fact, only 32% of actively managed equity funds have outpaced this unmanaged index, and no one has ever suggested a methodology by which those few winners could have been selected in advance.
And simple arithmetic makes it clear that this difference is critically important. Over 25 years, a $10,000 investment in the Index would have risen in value to $217,100, compared to $155,500 in the average fund. This shortfall - $61,600 - is clearly enormous. For over time, the miracle of compounding changes a difference in degree in annual return to a difference in kind in capital accumulation. Costs matter. That sums up the simple case for index funds.
Intelligent investors, however, will want more information about index funds, and you deserve it. Here is where W. Scott Simon's book enters the picture. Index Mutual Funds: Profiting from an Investment Revolution presents the complex case for index funds, an assiduous analysis of mutual fund past performance and a careful articulation of how index funds work, followed by a discussion of the role of index funds in an asset allocation program and their special cost, risk, and tax characteristics. I commend his fine book to you, for I believe index funds have a vital role to play in enhancing the long-term returns of your investment program.
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