A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

THE NO-BRAINER STEP:
INVESTING IN INDEX FUNDS
The Standard & Poor’s 500-Stock Index, a composite that
represents about three-quarters of the value of all U.S.-traded
common stocks, beats most of the experts over the long pull.
Buying a portfolio of all companies in this index would be an
easy way to own stocks. I argued back in 1973 (in the first
edition of this book) that the means to adopt this approach
was sorely needed for the small investor:
What we need is a no-load, minimum-management-
fee mutual fund that simply buys the hundreds of stocks
making up the broad stock-market averages and does no
trading from security to security in an attempt to catch
the winners. Whenever below-average performance on

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the part of any mutual fund is noticed, fund spokesmen
are quick to point out, “You can’t buy the averages.”
It’s time the public could.
Shortly after my book was published, the “index fund”
idea caught on. One of the great virtues of capitalism is that
when there is a need for a product, someone usually finds the
will to produce it. In 1976, a mutual fund was created that
allowed the public to get into the act as well. The Vanguard
500 Index Trust purchased the 500 stocks of the S&P 500 in
the same proportions as their weight in the index. Each
investor shared proportionately in the dividends and in the
capital gains and losses of the fund’s portfolio. Today, S&P
500 index funds are available from several mutual-fund
complexes with expense ratios less than 1/10 of 1 percent of
assets, far less than the expenses incurred by most actively
managed mutual funds or bank trust departments. You can
now buy the market conveniently and inexpensively. You can
also buy exchange-traded S&P 500 index funds offered by
State Street Bank, Barclays Global Investors, and Vanguard.
The logic behind this strategy is the logic of the efficient-
market hypothesis. But even if markets were not efficient,

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indexing would still be a very useful investment strategy.
Since all the stocks in the market must be owned by someone,
it follows that all the investors in the market will earn, on
average, the market return. The index fund achieves the
market return with minimal expenses. The average actively
managed fund incurs an expense ratio of about 1 percent per
year. Thus, the average actively managed fund must
underperform the market as a whole by the amount of the
expenses that are deducted from the gross return achieved.
The above-average long-run performance of the S&P 500
compared with that of mutual funds and major institutional
investors has been confirmed by numerous studies described
in previous chapters of this book. Yes, there are exceptions.
But you can count on the fingers of your hands the number of
mutual funds that have beaten index funds by any significant
margin.