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.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

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 (ARCA:VTI) which consists of all the regularly traded U.S. common stocks traded on the NYSE and Nasdaq. The Vanguard 500 Index concentrates on the S&P 500 basket of stocks.

Those seeking international exposure can invest in the iShares MSCI EAFE Index Fund (ARCA:EFA) or the iShares Emerging Markets Index (ARCA: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 (ARCA:FXI) or the iShares Brazil Index (ARCA: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. Mutual Funds & ETFs

    ETF Analysis: iShares 10-20 Year Treasury Bond

    Learn about the iShares 1-20 Year Treasury Bond ETF and its holdings, and understand why investors may be better served to look at other bond funds.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares Global Telecom

    Learn about the iShares Global Telecom exchange-traded fund, which invests in U.S. and foreign telecommunication companies with high dividend yields.
  3. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  4. Mutual Funds & ETFs

    ETF Analysis: United States Brent Oil Fund

    Learn more about the United States Brent Oil exchange-traded fund, the characteristics of the fund and the suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Ultra Bloomberg Crude Oil

    Find out more about the ProShares Ultra Bloomberg Crude Oil ETF, the characteristics of UCO and the suitability and recommendations of UCO for investors.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Hong Kong

    Learn about the iShares MSCI Hong Kong fund, which invests in various equities of companies listed on the Hong Kong Stock Exchange.
  7. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Growth

    Take a close look at the Vanguard Small-Cap Growth ETF, which focuses on domestic small-cap equities with a fundamental growth strategy.
  8. Mutual Funds & ETFs

    ETF Analysis: First Trust Dorsey Wright Focus 5

    Take a closer look at the First Trust Dorsey Wright Focus 5 ETF, a unique and innovative fund of funds based on momentum and relative strength.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares National AMT-Free Muni Bond

    Take an in-depth look at the iShares National AMT-Free Municipal Bond ETF, a highly diverse and very popular muni bond fund.
  10. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Lion economies

    A nickname given to Africa's growing economies.
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
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!