What is an index fund, or an Exchange Traded Fund (ETF), and why should the average investor care about them?

Take your average mutual fund. Perhaps it covers a specific sector, like biotech, or small-cap (capitalization) stocks. The fund manager had a great year last year, beating the market. That does not mean that the fund manager will have a great year this year, or ever again. The fund manager will buy and sell a lot of stocks during the year; the turnover may reach 100 percent. Each of those transactions means a fee that will be assessed to you, the investor. Even if the fee is only a fraction of a percent per transaction, it will add up over the year. In the past, it was possible for an investor to gain that vital bit of information allowing him to beat everyone else, and get in on the next Apple or Microsoft, before everyone else. That is not possible any more. The rules state that any information that can benefit one investor has to be made available to all investors at the same time.

The average index fund deals with a much broader part of the market, like the S&P (Standard and Poor's) 500. The fund manager buys shares in many, or all, of those 500 companies, and just holds them. The yearly turnover in stocks is closer to 10 percent, which means much lower fees for the investor. Year after year, index funds do a much better job of beating the market than the average active investor fund. There are tax advantages to index funds. The investor does not have to worry about why the fund has not bought shares in this or that hot new stock, so they can focus on their overall investment goals. Index investing may not be "sexy" or "exciting." but which is more important, excitement or profit?

For those who know their way around the investment world, this is a very interesting book. Maybe it is worth moving a small part of your portfolio into an index fund, especially if you are a conservative investor, and see what happens. Regardless, this book is well worth reading. ( )