PIMCO havoc makes the case for index funds

A Wall Street drama. A financial soap opera. Yes, the abrupt exit of bond king Bill Gross from the firm he co-founded, the mutual fund behemoth Pacific Investment Management Co., or PIMCO.

Gross had an incredible run as a bond investor. He realized after the inflationary 1970s that the underlying economic trend was toward lower inflation. But Gross lost his touch in recent years and his flagship bond mutual fund underperformed its peers and the market. Investors started withdrawing money. His autocratic management backfired.

In late September, Gross left for a rival firm before he was pushed out.

Several sentences in his 1997 book "Everything You've Heard About Investing Is Wrong" seem prescient. Gross was writing about the 1990s bull market in stocks, but the words just as easily capture his later predicament. "Being a superstar investor might have been as easy as being fully invested, packing your suitcase, and enjoying an extended vacation on the French Riviera," he wrote. "Usually life (and managing money) is just not that easy. When the flood comes or the tide changes, you'd better be prepared."

Gross wasn't.

That said, what is the implication of his story for the typical worker with a 401(k) or 403(b)? Gross' tale once again makes the case for saving with index funds.

I've been a fan of investing in broad-based, low-fee equity index mutual funds, bond index funds and the like. The scholarly evidence is overwhelming that most actively traded funds — from equity mutual funds to global hedge funds — don't do as well as a passive, indexed investment strategy. With an index fund, you aren't paying high fees to high-priced managers and teams of analysts who buy and sell securities to beat the market. Most don't.

Buffett is putting his vast fortune behind his recommendation when he dies. Here's what he wrote in his last letter to Berkshire Hathaway shareholders: "My advice to the trustee could not be more simple: Put 10 percent of the cash in short-term government bonds and 90 percent 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." (Another take away from the letter is that Buffett is bullish on the U.S. and global economies.)

Of course, index funds aren't exactly exciting. There's no Shakespearean tale of financial lions in winter. Nobel laureate William Sharpe once told me that indexing is "a dull, boring way to be a better investor than many of your friends." He's right. What's more, the strategy opens up time for other things than managing investments, such as taking a bike ride and watching the leaves turn on a beautiful fall day.