Beware of this costly Wall Street claim

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In a recent interview with CNBC's Sharon Epperson, Doug Lockwood, of Harbor Lights Financial Group, had this to say about index funds: "An index is a ship without a rudder in a market like this. You're going to go up with it, you're going to go down with it. Sure, it's going to be cheap, but you have zero chance of outpacing the market if you're buying the index itself."

Technically, of course, Lockwood is correct. But his statement is filled with the typical problems and misdirection that we see when active managers discuss indexing. Let's address two issues raised by Lockwood's statement.

A ship with no rudder

The problem with essentially calling index funds directionless is that the evidence on investing shows that not making decisions about stock selection and/or market timing has produced superior results to making them. In other words, investment ships are better off without highly paid rudders. Not only do the vast majority of actively managed funds underperform their appropriate risk-adjusted benchmarks, but there's no persistence of outperformance beyond the randomly expected. The result is that past performance has no value as a predictor of future results.

No chance of beating the market

Saying index funds can't beat the market is a perfect example of how paying attention to Wall Street and the financial media can be hazardous to your wealth. While Lockwood is basically right that investing in index funds gives you zero chance of beating the market (or appropriate benchmark), he has framed the question in a way that misleads the typical investor. 

Warren Buffett provided the right way to think about whether you should invest in index or actively managed funds. In the Berkshire Hathaway's 1996 annual report he wrote: "Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals." In other words, investors in index funds have very high odds of outperforming Lockwood and other active investors. That's what matters.

Wall Street and most financial media will continue to try to confuse investors about the benefits of indexing because to do otherwise would be the equivalent of committing economic suicide -- something few will do without a push.

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    Larry Swedroe is a principal and director of research for the BAM Alliance. He has authored or co-authored 12 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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