Index Funds Get No Respect

“The best way to invest is to just buy a low-cost index fund and keep buying it regularly over time.”—Warren Buffett

Index mutual funds are one of the most popular investments around. They feature low expense ratios and their returns consistently beat those of most of their actively managed fund cousins. They also offer instant diversification for a relatively small initial investment, along with some tax advantages. But many investment advisors, both in print and on TV, don’t give index funds much play.

Because they march in lock step with the market, index funds just aren’t sexy enough to get a lot of attention. They rarely make lists of hot funds and investment advisors seldom recommend them, often touting load funds instead. Pity the physician-investor who follows this advice. With the current average load up to 5.28%, an investor has a deep hole to climb out of before turning a profit.

Even no-load funds can be costly, however, levying outsize expense ratios on your assets. For that reason, the expense ratio is a key number to look at when investing in a mutual fund. According to Morningstar, the nation’s premiere mutual fund research company, the average expense ratio for a stock mutual fund dropped to 0.91% in 2007.

That’s still a lot higher than the 0.15% that Vanguard charges on its 500 Index Fund and you can expect to pay more than the average if you choose an actively managed fund. In fact, the Morningstar reports that much of the drop in the average stock fund expense ratio came about because investors switched to lower-cost funds.

11.5%—Average annual return for the Vanguard 500 Index Fund since its inception in 1976.(Vanguard.com, 2008)

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