Investing: The Zen of index funds

Everyone would love to beat the stock market, said William J. Bernstein in Money, particularly in these challenging times. “I’m sure you’ve heard that while it’s fine to ride the market’s gains when times are good, you need an expert stock picker when the bear roars. Wrong.” When the whole stock market is looking sluggish, the upside of taking chances with an actively managed portfolio is small and the downside potentially steep. “The best way to win this game is to not play it.” For now, stick your money in low-expense index funds that simply track markets you want to be invested in.

The returns posted recently by actively managed mutual funds have been “dismal,” said Paulette Miniter in SmartMoney. At Fidelity, which specializes in active funds, the average U.S. stock fund is down 34 percent this year—compare that to a 32 percent loss for index-fund shop Vanguard. The gap gets bigger when you consider that most active funds have higher expenses. Of course, some funds deserve the benefit of the doubt. Bill Miller’s Legg Mason Value fund, for example, is down a “whopping” 48 percent this year. But considering it once managed to beat the market for 15 years straight, his faithful investors trust that it will bounce back. “We’d expect it to lag badly at times, due to Miller’s bold approach,” says Morningstar analyst Greg Carlson. Down the road, that bold approach could pay off in spades.

If you haven’t already, now may be the time to invest in a fund that tracks the Standard & Poor’s 500 index, said Andy Louis-Charles in TheMotleyFool.com. Even Warren Buffett—probably the world’s best stock picker—thinks this will be the place most individual investors want to be when the rebound comes. Put money in gradually over the next few months. “If you buy it over time, you won’t buy at the bottom, but you won’t buy it all at the top either,” Buffett says. Sure, the index could fall further, but that just means more deals will be available: The average price-to-earnings ratio of the companies in the index is already about half what it was in early 2003.

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