Chris Farrell: Index funds can help you reach your retirement goals

For people saving in 401(k)s, IRAs and similar retirement savings plans, index funds are an invaluable innovation.

Broad-based equity index funds like the S&P 500 offer savers razor-thin fees and broad diversification. The so-called “passive” investment revolution is a smart way for individuals to invest for the long haul. In sharp contrast, the typical actively managed mutual fund charges too-high fees to underperform their benchmark indexes.

“Investments” is the widely used textbook by finance economist Zvi Bodie and co-authors, and they’re index fund fans.

“Whether you’re new to investing or not, an index fund is a great asset to add to your portfolio. It takes a little time to find the right index fund for you, but once you do, you can sit back and let your money grow,” the book reads.

Legendary investor Warren Buffett has agreed.

“Over the years, I’ve often been asked for investment advice,” he wrote in a 2017 letter to Berkshire Hathaway shareholders. “My regular recommendation has been a low-cost S&P 500 index fund.”

Little wonder indexing has become increasingly popular. The investment data company Morningstar reported passive funds closed 2023 with more assets than actively managed funds for the first time. Their calculations include equities, international equities and bond funds.

Of course, the rise of index funds and passive investment strategies comes under periodic attack, including now. Active fund managers have never liked the approach, and some scholars worry the market is too concentrated since four firms dominate it: State Street, Vanguard, BlackRock and Fidelity.

A recent economic study made the case that indexing might be undermining the efficient market hypothesis that supports the strategy. (The basic idea behind the hypothesis is it’s not possible to systematically beat the market since share prices reflect all critical information.) A strategist at Alliance Bernstein made a similar but more incendiary argument in “The Silent Road to Serfdom: Why Passive Investing Is Worse Than Marxism.” In a recent conversation with Cathie Wood, founder of Ark Investment Management, Elon Musk worried “the percentage of the market that is passive is simply ... too great at this point.”

The arguments from active fund managers are lame. Academic critics make some intriguing points, yet much of their observations are far from convincing in a global capital market. In the 401(k) era when the typical worker is responsible for managing their own retirement money, among the best options available to them include low-fee, broad-based index funds.

“Performance comes, performance goes,” Buffett wrote in his 2018 letter. “Fees never falter.”

Chris Farrell is senior economics contributor, “Marketplace”; commentator, Minnesota Public Radio.