Chapter 4 focused on the challenges involved in selecting from among the incredible variety of some 1,400 stock funds. At this point you may be asking: “Isn't there a better answer to the question of predicting, at least implicitly, the future relative performance of the fund chosen? Isn't there an alternative to moving from one fund to another as hope about a fund's strategy or its implementation by the fund's investment adviser turns to disappointment, and then again from disappointment to hope as the shares of the first fund are redeemed and the second purchased?” Speaking of this phenomenon among corporate pension funds, James Vertin, a pioneer in capital market theory, put it this way:
After twenty years of watching investment practitioners dance around the fire shaking their feathered sticks, I observe that far too many of their patients die and that the turnover of medicine men is rather high. There must be a better way.
He concluded, “And there is!”
What there is, of course, is the index fund. Simply put, an index mutual fund is a fund that owns a full participation in some particular segment of the financial market. By far the most common variety of index fund—and the one with the longest history behind it—is a fund that replicates the Standard & Poor's 500 Composite Stock Price Index. This index is heavily weighted by the stocks with the largest market capitalizations (for example, Exxon, General Electric, Philip Morris, AT&T, ...