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ETF Specialist

The Default Portfolio

A portfolio of low-cost index funds isn't a bad starting point for the average investor.

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Investing can seem like a daunting task. But low-cost index funds make it easy for the average investor to do better than he would with most professionally managed offerings, after fees. A broad-market index reflects the collective portfolio of all market participants and their view on the value of its holdings. In order for one investor to beat the market, someone else must underperform. Competition for superior performance creates a reasonably efficient market that is tough to consistently beat without taking on greater risk. The average actively managed dollar must underperform the average passively managed dollar because it incurs higher fees and, in aggregate, active investors define the market portfolio (1). But as Warren Buffett wrote in his most recent annual letter to Berkshire Hathaway shareholders: "Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit."

In the same letter, Buffett explained the advice he gave to the trustee for a bequest to his wife in his will: "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 Index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors--whether pension funds, institutions, or individuals--who employ high-fee managers."

Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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