Why Index Funds Took Over

For most of the twentieth century, investing in the stock market meant picking individual companies or paying a professional to pick them for you. Fund managers promised to beat the market, and investors paid substantial fees in return. Yet study after study found that the majority of actively managed funds failed to outperform a simple market index over long periods, especially once their fees were taken into account.

An index fund takes a different approach. Instead of trying to identify winners, it simply buys every stock in an index, such as the S&P 500, in proportion to its size. Because no expensive research team is required, the costs are remarkably low. Over decades, a difference of even one percentage point in annual fees can add up to a significant share of an investor's final savings, thanks to the power of compounding.

Critics argue that the popularity of passive investing has its own risks. If most money flows into indexes automatically, fewer investors are examining whether individual companies are actually worth their price. Some also worry that a handful of giant fund providers now hold large stakes in almost every major company, which could concentrate voting power in unprecedented ways.

Even so, for ordinary savers the lesson is fairly clear. Rather than chasing last year's best performers, many experts recommend a diversified, low-cost portfolio held patiently over time. It may sound boring, but in investing, boring is often exactly what works.