Why Index Funds

Why invest in indexes

There are people out there, and we've met plenty of them, who spend hours every week sweating over their investments. Some of these investing junkies actually seem to enjoy reading balance sheets and analysts' opinions.

Most of us, though, aren't like that. We want good performance with low risk — but between our jobs and our families we don't have a lot of time to follow the market.

If that sums up your situation, the perfect portfolio for you will not only beat the performance of most people who spend hours on their investing, it will beat about 80% of the money managed by professionals.

It's based on the simple fact that the market is smarter than any single individual. If the market says a stock is worth $20 a share, chances are the stock is probably worth somewhere close to $20 a share.

This may surprise you. Most market commentary is geared to making you believe that there are scads of undiscovered bargains out there. But think about how the world works and you realize how unrealistic that proposition is.

The best proof of the market's intelligence is that even the professionals can't keep pace with it. Over any period of a few years or more, about 80% of actively managed mutual funds lag behind the market. They're weighed down by the salaries of their managers, research costs, marketing expenses, fees paid to financial planners and trading expenses.

Here's where the Index investment strategy comes in. It's based on a simple idea: if active management doesn't beat the market, why not dump it and buy the market instead?

You buy the market by investing in a small collection of low-cost index funds. These funds passively follow the ups and downs of market indexes, such as the S&P/TSX Composite index of Canadian stocks or the Standard & Poor's 500 index of U.S. stocks. Your exact mix of funds can vary (and we'll get to the details in just a second), but the key advantage of the Index investment strategy is that it gives you wide diversification among hundreds of stocks and bonds at rock-bottom cost.

Why is this so important? Because low costs are crucial when it comes to investing success. Most investors pay about 2.5% to 4.5% of their assets each and every year to invest in actively managed mutual funds. On the other hand, you can invest in an Index investment with us for .95% or less a year. The couple of percentage points you save go directly to your bottom line and can have a tremendous effect over time.

Let's say you have a $200,000 portfolio. This year alone you would save about $4,000 by investing in an Index investment with us rather than with an investor in actively managed mutual funds. Over a few years, assuming you reinvested all of your savings, the difference would grow and grow, because the money you would be saving would compound on itself. Assuming typical rates of return, the money you would save by investing with us in an Index investment would be more than enough to buy you a luxury car in 10 years' time even if you were never to invest another cent in your portfolio.

Whenever we lay out the math, people are naturally skeptical. It seems too good to be true. How can the mutual fund industry get away with charging us so much for so little? Doesn't all that expensive professional management accomplish something?

Sadly, no. The Classic investment portfolio has generated returns higher than 11% over the past 30 years.

If you invested $100 in the Classic investment portfolio on January 1, 1976, it would be worth $3,163.45 as of December 31, 2006.