Why Index: Indexing versus Active Stock Trading

So far we've been comparing index funds with actively managed mutual funds; now we'll look at indexing versus stock picking.

If you invest in individual stocks then you probably already understand some of the advantages of index funds that you're missing out on: your portfolio is certainly less diversified than it could be; and it's probably less tax efficient, and incurs more trading costs as well. To overcome that drag you must believe that your stock picking skills will beat the index in the long run.

Now some finance professors claim that nobody can beat the market; but that's clearly an exaggeration since some people have in fact done it. It may be hard to come up with many documented examples (just like it's hard to think of anybody who owns a platypus) but the one example that everybody agrees on is Warren Buffett.

There are lots of books explaining Buffett's methods so that you can become like him yourself, so here's a fun personality test to help you decide how realistic that is. Just check off the boxes where you and Buffett have something in common:



Buffett You 
Unassuming nice person from Anytown, USA
Likes hamburgers, ice cream
Well groomed, good attitude
Pretty careful about personal expenses, credit cards, etc.
Studied finance at a good school (Columbia University) where he learned from a genius (Benjamin Graham)
who gave him an A+
Gained experience by working for a genius (Graham again) for several years
Has astonishing superhuman mental abilities, such as being able to memorize the earnings, cash flow, and book value of thousands of companies
Likes baseball
Plays bridge (with Bill Gates)


So how'd you do, Slugger? Maybe now you're ready for some friendly advice:

Over the [past] 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.

- Warren Buffett


Article Contents
Why Index? Intro
Fund Expenses
Style Drift
Stock Trading

Article Contents
Index Funds Article


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