Index investing is designed to provide broad market diversification at the lowest possible cost available. And by doing that, they provide all the benefits of diversified investing while minimising costs and keeping as much of the investment in the portfolio growing and compounding over time.
Volatile markets are interesting. Active fund managers tend to argue that their funds are going to outperform in volatile markets because there are greater opportunities to pick on stocks that might outperform or underperform relative to the benchmark. But the reality is that for every investor that picks a stock going in the right direction, there's an investor that picks a stock going in the wrong direction.
And so it's very difficult for active funds to outperform, regardless of how volatile the markets are. And data shows that on average active funds tend to underperform regardless of market environment, regardless of investment environments that benefit a particular investment style or investment strategy, and so it's usually easier to stick with an index fund and to just rely on the consistent performance that, regardless of market volatility, is going to deliver something close to the benchmark with relatively low cost drag.
One of the challenges is consistently beating the benchmark. So an investor could beat the benchmark in a particular year or a particular month, but to do that consistently, year in, year out is increasingly difficult. It's very difficult to continually be in the top half or certainly in the top quarter or higher of investment managers, which means that if I'm picking a fund and I look at it over a one year time period, maybe I do find a fund that beats it. As I go from one year to five years to ten years to longer, over the entire investment horizon that I might be considering, the chances that I'm actually going to find a fund that beats in all of those years, versus an index fund, is going to increasingly diminish. Odds are much more in favour of an index fund over an active fund during longer time periods.
Financial advisors want to look for investments that will provide their clients with broad market diversification at low costs. They want something that is going to provide consistent performance or outperformance, and index funds and ETFs are a great way of attaining that low cost investment strategy that their clients are looking for.
