Abstract
We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of nonstock holdings, whereas 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high-turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management.
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Charles Schwab
Chairman of the Board and Founder, Charles Schwab & Co., Inc.
"It's a very simple decision; 'Do I have enough money each month to put aside and where should I put it?' My recommendation is to put it in index funds, particularly as a younger starting investor.
One of the great features of index funds and broad based ETFs is that you get the advantage of broad diversification, you get many stocks.
So if you...let's say invest in an index fund or some with S&P 500 there'd be 500 companies, they represent about 70% of American's value of stocks, we have a fund called the Schwab 1000, it's 1,000 stocks, represents about 85% of the companies value in the United States. That is, of course, very broad diversification. And so if there's one industry that goes up, oil for instance, and another going down, utilities going down, you have an investment in every major sector of the economy."
Text: What is an Index Fund?
Voice over: "In the first video in this series, we looked at the importance of looking at stocks to grow your wealth. But choosing the companies and industries that will deliver the best earnings growth is a real challenge.
Competitive trends, management's ability to execute on their plans, and unpredictable events make it very hard to forecast results with success and consistency.
Most people just don't have the interest, time or expertise to pick individual stocks well. Multiply that effort by the many individual stocks you'll likely need for a well-rounded portfolio and the complexity adds up quickly.
Research shows how difficult it is, even for the pros, to actively buy and sell individual securities and match the market. So to get the best chances for building a portfolio that is designed to grow and to get invested in as many different companies in as many different sectors as you need to be well diversified, what do you do?
One of the easiest and low cost ways to get invested in as many companies as possible is to invest in a mutual fund or an Exchange Traded Fund (an ETF) to own a basket of companies. And a smart approach to that is index investing which provides two important advantages: Diversification and minimizing costs.
You're probably already familiar with indexes such as the S&P 500, the Dow Jones or the NASDAQ. In fact, when people talk about the stock market, they're usually thinking about an index. And while you can't invest directly in an index, many mutual funds and ETFs track these indexes simply holding the same stocks in the same proportion as are in the index.
Index funds can give you broad exposure to the market. Some are so broad in fact, that buying them means you own a tiny piece of almost every public company in America with just one investment.
Index investing can be a useful tool for both experienced and in-experienced investors to form the core of a well-diversified portfolio."
Text: What will it cost?
Voice over: "When it comes to investing, controlling costs is important. In fact, it's one of the few things you can control. Index funds are typically low cost compared to either buying stocks individually, where you pay a commission for each purchase or sale, or investing in managed funds, which pay managers to choose stocks and make trades.
And with the advent of ETFs costs drop dramatically. Now you can get access to the entire US Broad Stock Market for an annual fee of .03%. That means that on a $10,000 investment, you would pay a fee of $3 a year to own about 2,000 stocks. Lower costs means more money stays working in your portfolio and over time this can have a big impact on your outcome.
Charles Schwab: "To me there's lots of confusion in a discussion about investing and you want to make it simple. Some parts of the industry make it too complicated. Look for the firms, look for people who make it simple for you."