The best way to own common stocks is through an index fund

I would like start this topic with 3 great Investment quotes which supports the index fund (Passive management).


The best way to own common stocks is through an index fund
-Warren buffet



Why Pay people to gamble with your money
-William F. Sharpe , Nobel Laureate for economics


Wall street's Favorite scam is Pretending Luck is skill
-Ron Ross, PhD., The Unbeatable Market


So before going into the Index funds, Let’s look back the history of actively managed Equity funds. First let’s take the Wall Street and analyze how many of the actively managed Equity funds had outperformed the Vanguard 500 Index fund people who don’t know what’s Vanguard 500 Index fund.

One year:
1,186 of 2,423 funds (or 48.9%)

Three years:
1,157 of 1,944 funds (or 59.5%)

Five years:
768 of 1,494 funds (or 51.4%)

Ten years:
227 of 728 funds (or 31.2%)

Fifteen years:
125 of 445 funds (or 28.1%)

Twenty years:
37 of 248 funds (or 14.9%)

This data clearly shows that in a long run equity funds opens the way to Low cost index funds.
Since because of the funds high expense ratio and bad behavior, most funds fail to earn their keep. The high returns generated by the funds always vanish in a long run. What’s more, as time passes, the drag of their excessive expenses leaves most funds farther and farther behind.


Let’s do one more analysis. Instead of taking Wall Street let’s take Dalal Street. When I thought of making this statistics, I could able to find only around 30 Equity Funds which is having a existence more than 10 Index. So I considered the basic years, and to our chagrin there is no other Index fund which tracks BSE 500 assumption that Index funds would almost replicate the performance of its Index with a very small have Tracking Error.



In the chart above , I haven’t included all the 30 Equity funds; rather I picked around 16 funds though the funds what I haven’t included almost 99% lost to the BSE 500 Index. These data points again stress that in a long run equity funds opens the way to Low cost index funds because of their low management fee and trading costs.

What, then, should the intelligent investor do?

First of all, recognize that an index fund- which owns all the stocks in the market, all the time, without any pretense of being able to select the “best” and avoid the “worst”—will beat most funds over the long run.

Consider this. If stocks generate, say, a 7% annualized return over the next 20 years, a low-cost index fund which tracks S&P 500 or BSE 500 index will return just under 6.7%. (That would turn a Rs 10,000 investment into more than Rs 36,000.) But the average stock fund, with its 1.5% in operating expenses and roughly 2% in trading costs, will be lucky to gain 3.5% annually. (That would turn Rs10,000 into just
Under Rs20,000—or nearly 50% less than the result from the index fund.)
This is surely a paradox. All the investors should realize this.

The most important thing is, one should take the broad category of index for comparison like S&P 500 or BSE 500 index because this gives you ample diversification and the growth from all broad categories..So just don’t see the index fund which tracks just 30 or 50 or even 100 stocks. Most of the Indian Index fund tracks the BSE Sensex (30) or a Nifty (50) stock which is not going to help us.

Once Buffet quoted a famous analogy about active investing, consider that tomorrow 225 million people in America with each having a dollar, comes out and tosses a coin and those who tossed a tail had to give his dollar to the person who calls a head. Eventually after repeating the process many times there is one guy standing who has a track record of always tossing heads, had made a single dollar to 225 million dollars. From the very next day he writes books how to turn a dollar to 225 million dollars..
Everyone starts to speak about him, and follows him and boasts him.


Index funds have only one significant flaw, they are boring. You’ll never be able to go to a show off and brag about how you own the top-performing fund in the country. You’ll never be able to boast that you beat the market, because the job of an index fund is to match the market’s return, not to exceed it. Your index-fund manager is not likely to “toss a coin” and gamble that the next great industry will be the technology or Banking, or telepathic weight-loss clinics; the fund will always own every stock, not just one manager’s best guess at the next new thing. But, as the years pass, the cost advantage of indexing will keep accruing relentlessly. Hold an index fund for 20 years or more, adding new money every month, and you are all but certain to outperform the vast majority of professional and individual
investors alike.

I do accept that each year 1/3 of the funds beat the Market , But each year they are different.