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Sunday
Jul172011

Physician Investing: Why Indexing Works

Watch this short video from Vanguard to learn why index funds beat actively managed funds.

Here are a few highlights from the video:

1. Investing is not a zero sum game but active management is a zero sum game. What this means is that when you invest in the market you are expected to be rewarded over long periods of time with market returns. As a group active managers must have the same performance as index funds BEFORE fees. After fees, active managers as a group always underperform an index. This has to be the case because the market is made of active managers and passive investors. So if the passive investors are getting the market return then it has to be the case that active managers are also getting the market return.

2. There will always be active managers from one year to the next who outperform an index. The problem is that the active managers who outperform in one year are unlikely to repeatedly outperform in the next few years.

Remember that active managers are smart people. I'm not suggesting they are dumb or incompetent. What I'm saying is that the competition between active managers is so high that it's almost impossible to outperform an index consistently in the long run.

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