Nobel Prize Winner Recommends Index Funds

Money magazine's June issue has an interview with Bill Sharpe, the man who won the Nobel Prize for his pioneering theory on the interplay between investment risk and return (basically, the more the potential return, the more risk -- I know, seems simple, but it's a tad more complicated than that. Then again, I may enter the rule of 72 into the Nobel Prize competition myself next year.) ;-)

Anyway, they got around to the subject of index funds and he had something to say that I just HAD to share with you all (I'm sure you can guess what it is.)

But before we get to that, let's follow the line of questioning. It started with him saying:

If you want more return, you have to take more risk of doing badly in bad times. You can't just say, "Let's go for a really hot stock." That doesn't guarantee a higher return.

So they ask him what does guarantee a higher return to which he responds:

The only way to be assured of higher expected return is to own the entire market portfolio.

Oh, yeah. You can see where this is heading now!!!!!!!!

So Money says/asks:

You can easily do that through a simple, cheap index mutual fund. Why doesn't everyone invest that way?

Holy cow -- these people are reading my mind!!!!

He responds:

Hope springs eternal. We all tend to think either that we're above average or that we can pick other people [to manage our money] who are above average. That's what makes markets -- when one person thinks he knows more than somebody else, information is exchanged and a new stock price is set. And those of us who put our money in index funds say, "Thank you very much." We get to free-ride on other people's convictions.

Not much more I can add here. Just another post that demonstrates why I like index funds.

If you'd like to see more articles on this issue, check out these links:

• Why Index Funds Deliver Such Great Returns

• The Two Reasons Index Funds Perform So Well

• All Index Funds Are Not Created Equal

• Another Expert Endorses Index Funds

Comments

[Famulus]

Interesting post; thank you! I just began a personal finance blog and I thought you and your readers might enjoy to read my perspective on the topic (I'm a 30 something professional working in Washington DC).

Keep up with your great posts!