PDF ‘The Bagel and the Index Fund’
By Russell Roberts
January 20, 2004
Businessweek and the Invisible Heart (Article dug up by Sameer Desai)
After a good year for the stock market, a lot of investors are feeling it’s safe to get back in the water. And despite the recent scandals, a lot of money will be going into mutual funds as the economy and market continue to recover. But which funds should you consider?
Study after study finds that indexed funds are superior to managed funds, particularly over a long period of time. In the face of this evidence, why do so many investors still turn to managed funds? Maybe it’s because a lot of people still feel just a little bit foolish buying an indexed fund. How smart can it be to let a computer run your portfolio? How hard can it be to find a manager smart enough to outperform a mindless algorithm?
The emotional and intellectual appeal of managed funds comes from our daily lives, where managing things usually trumps a strategy of letting things take care of themselves. It’s good to organize your monthly bills rather than picking one up whenever you think of it and paying it. It’s good to keep your children away from a hot stove rather than letting them discover the dangers of life by trial and error.
ARMY OF BAKERS. Such real-life experiences can mislead, though, when it comes to some financial decisions. To understand the virtues of an unmanaged indexed fund, consider the world of bagels. Did you ever stop to wonder how it is that in Washington, D.C., where I live, and in every other city of any size in America, bagel shortages never happen? Read more…
From the article, “Once you understand how the bagel market, while imperfect, functions smoothly without a manager, you can begin to appreciate the wisdom of buying an indexed fund. Prices, after all, capture information. The best stocks end up being more expensive than those with worse prospects. The expected return is that of the market as a whole. Bargains can’t be identified in advance. Turns out the best strategy is to avoid the fees and tax consequences of managed funds and take the return of the market as a whole.”
