Index funds such as those offered by Vanguard have become increasingly popular over actively managed mutual funds. There are several reasons for this: Lower fees. Index funds simply track a market index and don’t require extensive research and high-paid analysts and stock-pickers. This results in much lower expense ratios, often less than 0.1%. Better performance. Numerous studies show that index funds consistently outperform the majority of actively managed funds over long time horizons, thanks to their lower costs. Less risk. Index funds provide instant diversification across hundreds or thousands of stocks, reducing volatility versus trying to pick individual winners.
Index funds benefit from huge scale and massive flows
The index fund sector has become heavily concentrated in the Big Three of BlackRock, Vanguard, and State Street. They benefit enormously from economies of scale, allowing them to drive fees to rock-bottom levels. This virtuous cycle attracts even more assets from investors. For example, index funds and ETFs took in $500 billion of net new money in 2016 while actively managed funds saw $300 billion in outflows. This consolidation means the Giant Three could soon control 40% of votes in S&P 500 companies, raising corporate governance issues.
Relatively few stock pickers consistently beat the market
While some celebrity investors like Warren Buffett have beat the markets for decades, far more fail to match index fund returns over the long run when their high fees are taken into account. Picking individual stocks that outperform is very difficult even for professionals. By buying and holding the entire market, index funds avoid this stock-picking challenge. They may lag in frothy bubbles but consistently do better over full cycles.
Passive investing makes markets more efficient
The popularity of low-cost indexed investments has helped make markets more informationally efficient. Index funds reduce the number of speculators focused on predicting next quarter’s earnings and chasing momentary stock price pops. This demand has shifted towards long-term value investing, improving price discovery and capital allocation in public markets.
In summary, index funds like Vanguard offer significant advantages including much lower fees, better aggregate performance, lower volatility through diversification, and positive impacts on market efficiency. The index fund industry will likely continue to concentrate into an oligopoly of just a handful of massive players such as the Giant Three.