The average consumer has likely never heard the name, John Bogle. Bogle, founder of the Vanguard Group and creator of the first index fund, doesn't get as much love as he deserves from the investing world. The company he founded now has $1.7 trillion under management, but he was forced to retire at the mandatory age of 70 and for many industry professionals, the hope was that his retirement would silence a man who was fiercely critical of the world of mutual funds. That didn't happen.

Bogle has long said that the mutual fund world suffers from high fees and lack of accountability to shareholders, as well as too much turnover within the fund, producing extra taxes and commissions.

However, Bogle isn't just hard on the professionals. He and many others believe that trying to be a better stock picker by selecting individual stocks and trying to buy them at just the right time, is a mathematical impossibility. If everybody is trying to beat the market but everybody is the market, they're almost trying to outsmart themselves.

SEE: Stop Paying High Mutual Fund Fees

Bogle created the index fund as a means of removing the many variables that are nearly impossible to overcome. He said of the index fund, "index funds eliminate the risks of individual stocks, market sectors and manager selection. Only stock market risk remains."

However, even index funds have variables and picking the wrong funds can have the same negative effect on your portfolio as other funds. If you're planning to fill your portfolio with index funds, here's what you should look for in a high-quality fund.

1. Low Expenses
Index funds, by their nature, are low-fee instruments, but even Vanguard has funds like the 500 Index Admiral Shares, with an expense ratio of .05%, and the Global ex-U.S. Real Estate Index, which has a 0.50% ratio. Other companies have funds that are even higher.

Picking funds solely based on fees isn't an advisable strategy, but minimizing expenses as much as possible always translates to a higher portfolio balance.

2. Correlation to the Underlying Index
What good is an index fund if it isn't correlated to the market? If the S&P 500 is up 1% during the past six months but your S&P 500 index fund is only up 0.7%, there's a correlation problem likely resulting from high fees eroding the performance. There will not be 100% correlation but it should not be far off. Make sure to check the correlation over longer periods of time, as well.

SEE: The Importance Of Correlation

3. No Narrow Funds
The reason there are so many index funds available is because there are a lot of indexes and most aren't worth your time. Although it might make you sound sophisticated to say you own the iShares MSCI Israel Capped Investable Market Index Fund, investing in a fund that is confined to Israeli holdings is a lot like stock-picking, except that you're attempting to time the performance of a single country, and you're paying 0.59% in expenses to do it.

4. The Index Is Easy to Understand
Most investors who have the knowledge and experience to pick their own funds, know and understand the S&P 500. It's an index based on 500 stocks representing a cross section of the economy. You could invest in the ADCARAB index fund (even this ticker looks intimidating) but before you do that, you'll need to know a lot about the S&P Pan Arab Composite Large/Midcap Index. If you don't, you might want to stick to funds that track indexes, like the Russell 2000 and the Nasdaq.

SEE: Index Investing Tutorial

The Bottom Line
Bogle believed in keeping investing as simple as possible by removing variables that were largely out of the control of most investors. The index fund does that by removing stock picking, money managers, large amounts of turnover and other expenses that come with actively managed funds. He believes, and other research agrees, that trying to beat the market will not result in large-scale gains over time.

Related Articles
  1. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  2. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  3. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  4. Mutual Funds & ETFs

    Top 4 Global Real Estate Mutual Funds

    Read about four of the best global real estate mutual funds, which invest in the securities of real estate companies or real estate investment trusts (REITs).
  5. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  6. Professionals

    Top 5 Highest Paid Hedge Fund Managers

    Understand what a hedge fund is and why hedge fund managers make so much money. Learn about the top 5 highest paid hedge fund managers.
  7. Investing Basics

    6 Reasons Hedge Funds Underperform

    Understand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
  8. Mutual Funds & ETFs

    Mutual Funds Are Not FDIC Insured: Here Is Why

    Find out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
  9. Professionals

    How to Sell Mutual Funds to Your Clients

    Learn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
  10. Mutual Funds & ETFs

    Top Three Transportation ETFs

    These three transportation funds attract the majority of sector volume.
  1. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  2. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  3. Do financial advisors get paid by mutual funds?

    Financial advisors are reimbursed by mutual funds in exchange for the investment and financial advice they provide. A financial ... Read Full Answer >>
  4. Why is fiduciary duty so important?

    Fiduciary duty is one the most important professional obligations. It basically provides a much-needed protection for individuals ... Read Full Answer >>
  5. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  6. Why do financial advisors have a fiduciary responsibility?

    Financial advisors governed by fiduciary duty are bound by law to act in the best interests of their clients at all times. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!