Although simple in theory, the strategy of investing in indexes is arguably one of the most successful investment strategies for the vast majority of investors today. Yet so many people prefer to participate in individual securities, arguing that they can beat the market. While it's possible to beat Mr. Market, very few people can do it over the long-run.

IN PICTURES: 20 Tools For Building Up Your Portfolio

Why Not?

The reason most people fail to beat the market over a meaningful period of years has nothing to do with intelligence, but everything to do with behavioral finance, a discipline that examines why market participants behave the way they do.

One critical reason for market under performance by the majority is simply a result of all wanting to be invested in the same thing. Common sense will tell that if you invest in a space populated by the masses, you are investing in the most efficient of all markets. As a result, you will be investing in lockstep with the market. But you will do so while incurring frictional costs - commissions, taxes, etc. - absent from simply being in an index fund.

The Irony of Investing
Different studies reveal different percentages of those who fail to beat the market. According to a past speech by mutual fund giant John Bogle, 85% of active professionals fail to beat the market by three percentage points. Other studies simply show that 75% of active money managers fail to beat the S&P 500 index.

Whatever the number, what is beyond dispute is that a vast majority of pros fail to beat the market. Yet by investing in an index fund, a man or woman with zero knowledge of markets, finance, accounting or any other prerequisite for investing, can beat a majority of professionals. I can't think of any other profession where this is possible. You don't see individuals walking into hospitals and telling doctors to step aside because they can operate better. Such is the irony of investing. (For more on this topic, see Intro To Index Investing.)

Excellent Exposure
Thanks to the innovation of the capital markets over the years (not all market innovation has been bad!), investors can now be exposed to other regions besides the United States. The most comprehensive exposure to the U.S. stock market can be found in the Vanguard Total Stock Market Index (Nasdaq:VTI) which consists of all the regularly traded U.S. common stocks traded on the NYSE and Nasdaq. The Vanguard 500 Index (Nasdaq:VFINX) concentrates on the S&P 500 basket of stocks.

Those seeking international exposure can invest in the iShares MSCI EAFE Index Fund (NYSE:EFA) or the iShares Emerging Markets Index (NYSE:EEM) which tracks the emerging markets. Thanks to exchange-traded funds, investors can now make broad bets on the equity performance of certain countries as well like the iShares FTSE/China 25 Index (NYSE:FXI) or the iShares Brazil Index (NYSE:EWZ). In all instances, these funds or ETFs have very minimal expenses compared to mutual funds which often hold similar securities.

The Bottom Line
You don't need to be a brilliant stock-picker to beat the market, but rather a rational and patient investor. And for the majority of folks who can't expend the rigor and effort to analyze securities, participating in index funds is a brilliant strategy. (For more, see Investing With A Purpose and The Successful Investment Journey.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing Basics

    Building My Portfolio with BlackRock ETFs and Mutual Funds (ITOT, IXUS)

    Find out how to construct the ideal investment portfolio utilizing BlackRock's tools, resources and its popular low-cost exchange-traded funds (ETFs).
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Investing

    3 Things About International Investing and Currency

    As world monetary policy continues to diverge rocking bottom on interest rates while the Fed raises them, expect currencies to continue their bumpy ride.
  7. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  8. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  9. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  10. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
RELATED FAQS
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center