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A Practical Approach to Low-Cost Investing
Book Review

 

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Whitepaper: A Case For Index Fund Portfolios

Co-written by Rick Ferri, CFA, Portfolio Solutions and
Alex Benke, CFP, Betterment

Published: June 2013

The success of index investing in individual asset class categories has been widely documented; however, surprisingly little research is available that compares the performance of diversified portfolios of index funds with portfolios of actively managed funds. The analysis has been hindered by the relatively short length of time index funds have been available in most asset classes and a survivorship bias that existed in most commercially available mutual fund databases.

A prudent mutual fund selection strategy is important to an investor’s wealth accumulation. Two distinct strategies are compared in this report: one that selects low-cost market-tracking index funds exclusively and a second that selects from actively managed funds that attempt to outperform the markets. Overwhelming evidence is found in support of an all index fund strategy.

The research is unique in that the actual performance of index funds and actively managed funds are used throughout the study. Each portfolio was formed using the CRSP Survivor-Bias-Free US Mutual Fund Database, which includes funds that have failed or merged over the years. This robust database enabled the replication of the real-world experience of investors who could not forecast which funds would survive at the time they made their investment decisions.

The outcome of this study favors an all index fund strategy. The probability of outperformance using the simplest index fund portfolio started in the 80th percentile and increased over time. A broader portfolio holding multiple low-cost index funds nudged this number close to the 90th percentile. These results have significant and practical implications for investors seeking a strategy that can give them the highest chance of reaching their investment goals.

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