Legendary Investors Agree on Index Funds

Renowned investor Warren Buffett is an advocate of index investing. Most recently, in his 2014 letter to shareholders, Buffett stated that he has directed the trustee of his sizeable inheritance invest in just two investment vehicles: 10% is to go into short term government bonds, and the 90% balance to simply go into index funds1. Buffett's affinity for indexing is not new news. For many years, he has promoted index investing in several of his letters to shareholders. For example, in his 2004 letter, Buffett stated that "Over [the past] 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback corporate America in a diversified, lower-expense way. An index fund they never touched would have done the job. Instead, many investors have had experiences ranging from mediocre to disastrous."2

Buffett not only advocates index funds, he's betting on them.  The June 2008 issue of Fortune3 Magazine reported that Buffett wagered a million dollars that an S&P 500 index fund's ensuing 10-year returns would beat those of five actively managed funds or hedge funds chosen by Protege Partners, a prominent New York-based asset management firm. Passing the 6-year mark on December 31, 2013, the Vanguard fund picked by Buffett is up by 43.8%, while the five hedge funds have gained only 12.5%. Since it is highly unlikely this will reverse, our money is on the Oracle of Omaha.

Many highly respected financial experts affirm Buffett's high regard for index funds. In his book, Charles Schwab's Guide to Financial Independence, Schwab revealed, "Most of the mutual fund investments I have are index funds, approximately 75%."4

Benjamin Graham, influential economist and mentor to Warren Buffett, spent most of his professional life analyzing companies for stock market bargains. However, shortly before his death in 1976, Graham rejected his long-held belief that investors could expect to beat the market through individual stock analysis. Graham was visionary in his early description of what is now known as a value index fund.

Noteworthy institutional investors also advocate index funds investing. David Swensen, Chief Financial Officer of the highly successful Yale Endowment Fund and author of Unconventional Success: A Fundamental Approach to Personal Investment5 and Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment,6 has been particularly outspoken about the pitfalls of active investing and the merits of index investing for individual and institutional investors alike. In an August 2011 article which appeared in the New York Times, Swensen blasted active investing and its facilitators, including mutual fund companies, retail brokers and advisors. He said that market volatility causes ill-advised investors to behave "in a perverse fashion, selling low after having bought high." He asks, "What should be done? First, individual investors should take control of their financial destinies, educate themselves, avoid sales pitches, and invest in a well-diversified portfolio of low-cost index funds."7

Bear the Risk
Bear the Risk

So what is the lesson here? Like the illustration titled Bear the Risk, when you fully embrace a new way of investing, you can substantially reduce the stress and anxiety commonly experienced by active investors. You should be calmer, relaxed and more centered in the midst of the noise and frenzy of media pundits and Wall Street. An unwavering commitment to your investment plan should allow you to let go of unnecessary worry and enable you to focus on what truly matters to you most. You should not only be rewarded emotionally, but you will also improve your probability of investment success. Why would you want to do anything else?

    -1 Maureen Farrell, "Four Long-Term Investing Tips From Warren Buffett," The Wall Street Journal, February 28. 2014, http://blogs.wsj.com/moneybeat/2014/02/28/four-long-term-investing-tips-from-warren-buffett/
    -2 Warren Buffett, Berkshire Hathaway Letters to Shareholders 1965-2012, (Max Olson, 2013)
    -3 Carol J. Loomis, "Buffet's Big Bet," Fortune, June 23, 2008.
    -4 Charles Schwab, Charles Schwab's Guide to Financial Independence: Simple Solutions for Busy People (New York: Three Rivers Press, 1998).
    -5 David Swensen, Unconventional Success: A Fundamental Approach to Personal Investment (New York: Free Press, 2005).
    -6 Swensen, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment.
    -7 David Swensen, "The Mutual Fund Merry-go-Round," New York Times (New York, NY), Aug. 13, 2011.
Step 1Warren BuffetFortune MagazineBenjamin GrahamDavid Swensen