Index funds are not evil, they are not destroying the markets, and will not blow-up your portfolio. To the contrary, they have outperformed most active investment strategies and continue to save investors billions of dollars per year in fees.
As index investing became popular and assets flowed in, news articles denouncing the strategy also increased. The critics of index investing range from big fund companies to small investment advisers who claim to have strategies that perform better. Their complaints run the gamut from minor nagging about how index funds and ETFs increase portfolio risk to outrageous warnings that these products will someday cause a global apocalyptic event. The research cited, when there is any, is often conjured up by an active fund company that’s trying to hold onto their dwindling market share.
These claims have little academic substance, yet anti-indexing articles get an enormous amount of media attention because their provocative headlines evoke fear in investors. One prominent asset manager wrote in a widely disseminated report that passive investing is “worse than Marxism” and will lead to a cataclysmic event. A recent article on Forbes.com titled, Why Most Index Funds are Not Good Investments, received over 110,000 views.
A small investment adviser from Wisconsin who favors active strategies wrote the Forbes article. His conclusions about index funds were far different than the evidence available in all the mainstream studies of passive versus active investing. This caught the attention of Jason Zweig, a prominent journalist at the Wall Street Journal.
Zweig talked with the adviser and investigated his data source. He found a slanted Fidelity internal report for adviser use only that claimed active managers outperformed index funds in most styles. However, in the back of the report, in small print, was a note stating the active fund data Fidelity used to make this claim was incomplete. High fee active funds and poor performing active funds were excluded.
Zweig published his findings in an article titled, Fidelity’s Index Fund Bashing Misses the Mark. He could have bashed the adviser also, but he left him relatively unscathed. Fidelity removed public access to the study after Zweig exposed the flaws.
It’s hard to kill a great idea, especially one that has been around a while and saves people billions in fees per year. Some say this shift is a threat to market integrity and others say it’s dangerous. I say indexing is a great idea that keeps getting better. The shift in investor preference from a rent-it active fund mentality to an own-it index fund mindset has hurt the profits of active fund companies and the brokers that make money on commissions, but it helps investors by saving on fees, trading costs, and taxes.
The truth about index funds must be repeated often because lies are constantly being told. They are successful because they are good. Those who cry wolf either don’t know the truth or have a strong financial incentive to ignore it.
Rick Ferri, CFA, CEO of Ferri Investment Solutions and Core-4 Portfolios
By Rick Ferri