The Case for Boring: Why Index Funds Suit Most Investors

An index fund does something almost insultingly simple: it buys every company in an index, in the same proportions, and holds them. No research team, no market calls. So why do so many experienced investors end up recommending them?

The arithmetic

In 1991, the economist William Sharpe pointed out something that sounds obvious once said. Before costs, all investors together earn the market's return, because together they are the market. After costs, the average active investor must therefore earn less than the market, by roughly the amount they pay.

An index fund charging 0.1 to 0.3% a year keeps almost all of the market's return. An active fund charging 1 to 2% has to beat the market by that much every year just to match it.

The evidence

S&P's SPIVA scorecards regularly find that a majority of Indian large-cap funds underperform their benchmark over five and ten years. The picture is more mixed for mid and small caps, where active managers have had more success, but the large-cap result has been consistent.

The behavioural bonus

Index funds have one more advantage: there's nothing to chase. No star manager leaving, no fund topping this year's charts. That removes the temptation to switch, which is one of the most expensive habits in investing.

↗Try the sip calculatorWhat a monthly SIP could grow into.

What to check

Look at the expense ratio (lower is better), the tracking error (how closely it follows the index) and the fund size. Then set up a SIP and let it be boring for a very long time.

Source: William F. Sharpe — The Arithmetic of Active Management (1991)