The Stock Market Index Revolution

The Index Revolution: Why Investors Should Join It Now by Dr. Charles Ellis explained a lot of the changes that I have witnessed in the stock market over the last 40 years. Dr. Ellis has a great deal of experience managing large pension funds and wealth funds. He explained the reasons why investing by amateurs like me no longer works and why it makes sense to invest in indexes.

In the 1960’s 99% of stock market trades were by amateur investors who traded just a few times a year. Today, less than 1% of stock trades are by amateur investors. Now, over 1.5 million professional traders, mutual funds, pension funds, and automated trading systems make 99% of the world-wide stock trades.

Full time professional and institutional traders take advantage of underpriced stocks by finding them faster than amateur investors. They do it by getting instant and detailed information about companies unavailable to amateurs.  Stock information sources can cost over $20,000 a year, impossibly expensive for an amateur like me managing my IRA and small portfolio of individual stocks.

Over the past 40 years, the trend toward professional and institutional stock trading led to the creation and spectacular growth of professionally managed mutual funds. Although the “famously successful mutual fund managers” paid huge salaries touted that their mutual funds performed better than the overall market, academic researchers found that over the past decade only one or two of their mutual funds out-performed the S&P 500 stock index. And, after the cost of trades and the high management fees, none of the mutual funds out performed the S&P 500 index.

The stock market generally goes up about 8% per year, averaged over 10 years. The expense of trades and staff, which is commonly 4% of the gain, can cut the long term appreciation of an investment portfolio by 50% of even the best performing mutual funds. Most of the mutual funds do not come close to matching the performance of the overall stock market index, but even if they did the net result would be less because of their costs.

These findings published by academia have led to a mass exodus from mutual funds to exchange traded index funds (ETFs).

The author’s career included managing foundation portfolios as well as researching stock fund results at Yale, Harvard, and Princeton. His unique experience makes the book an especially enjoyable read. I was so impressed with the data and view he presented that I immediately started moving out of individual stocks into ETFs. It has been about 90 days since I started and I am already very happy with the greater stability of the ETFs; no more disturbing daily volatility of individual stocks.

I highly recommend the book. Five stars.