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For people who save in 401(k)s, IRAs, and similar retirement savings plans, index funds are an invaluable innovation.
Broad equity index funds like the S&P 500 offer very low fees and wide diversification. The so-called “passive” investing revolution is a smart way for individuals to invest for the long term. In contrast, a typical actively managed mutual fund charges too high fees to underperform its benchmark index.
Investing is a widely used textbook by financial economist Zvi Bodhi and his co-authors, who are also fans of index funds.
“Whether you’re new to investing or not, index funds are a great asset to add to your portfolio. It takes some time to find the index fund that’s right for you, but once you do, you can sit back and enjoy it. “You can trust your investments, and your money will grow,” the book says.
Legendary investor Warren Buffett agrees.
“Over the years, I have often been asked for investment advice,” he wrote in a 2017 letter to Berkshire Hathaway shareholders. “I always recommend low-cost S&P 500 index funds.”
No wonder indexing is becoming more popular. Investment data firm Morningstar reported that passive funds ended 2023 with more assets than actively managed funds for the first time. Their calculations include stocks, international stocks, and bond funds.
Of course, the rise of index funds and passive investment strategies has come under attack regularly, including now. Active fund managers have never liked this approach, and some academics worry that the market is too concentrated, with four companies dominating it: State Street, Vanguard, BlackRock, and Fidelity.
Recent economic research has argued that indexing may undermine the efficient market hypothesis that underpins the strategy. (The basic idea behind this hypothesis is that it is impossible to systematically beat the market because stock prices reflect all important information.) Strategist at AllianceBernstein makes a similar but more incendiary argument in “The Silent Road to Serfdom: Why Passive Investing is Worse.” than Marxism. ” In a recent conversation with Ark Investment Management founder Cathie Wood, Elon Musk worried that “the passive portion of the market is simply too large right now.”
Active fund managers’ arguments are insufficient. Although academic commentators have made some interesting points, many of their observations are far from convincing in global capital markets. In the 401(k) era, when the average worker is responsible for managing their own retirement funds, some of the best options available to them include low-fee, broad-based index funds. will appear.
“Performance comes and performance goes,” Buffett wrote in a 2018 letter. “Prices will never go down.”
Chris Farrell is a senior economics contributor for Marketplace. Commentator for Minnesota Public Radio.
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