In this article, Exploding Myths, a Yahoo Finance columnist, Julia Lee, seeks to "explode" the myth of index funds. Her recommendation is to buy into value, because index funds only work in a world where the Efficient Market Hypothesis (EMH) is perfectly true. In fact, she holds the EMF to be mythical, and therefore index funds are mythical. She points out that Warren Buffet does not believe in the Efficient Market Hypothesis. He probably doesn't. No one believes the EMH is literally true (I'll get back to this)
One of the more annoying things about Ms Lee's article is that Warren Buffett has consistently recommended that ordinary investors should choose index funds, easily verified by google "Warren Buffet index funds". I did not know that he had endorsed index funds, but he is such a sensible person and index funds are such a sensible idea that his endorsement of them seemed extremely likely. My first google search proved the point very quickly. I don't much of Ms Lee's name dropping; my cross-examination of Mr Buffett would be embarassing for the prosecution, I think.
Warren Buffett is a famous proponent of value investing, as recommended for ordinary investors by Ms Lee. Of course, Mr Buffer's modus operandi is to find a company meeting his requirements for value investing (which we can all do, with varying degrees of skill), buy a controlling stake and then to start actively managing it. Which ordinary investors can't do. The difference between having the resources to actively influence a company's management and being a passive investor is why Mr Buffett recommends index funds for the rest of us.
If you dismiss index funds, you are really dismissing the idea of funds altogether. Why did funds become popular for small investors, as opposed to holding a number of individual stocks? Because funds offer diversity. For the same amount of money, you can hold shares in more companies. You'll never guess where this idea came from: the Efficient Market Hypothesis. Index funds offer the perfected fund: holding a broad range of shares, and with very low overheads. What is a myth? How about believing that a fund manager can hand-craft a selection of stocks to beat the market for more than two years in a row. The facts suggest that this is much more likely to be a myth.
An index fund is simply a portfolio of published group of stocks. It saves money because no one is churning trades of shares (the index being fixed), and it's easy to understand. Every portfolio has its risks, and every index fund is a subset of all the shares on earth. At least with an index fund, it is easy and cheap to compare the risk of a certain portfolio. The investor has a huge range of indexes to choose from. You still need to choose an index matching your risk profile. Do you want to invest in the S&P 500? Or European biotechs?
By the way, almost no one believes in the EMH literally, and certainly its authors never intended it to be more than an approximation. Tying index funds to the EMH is the "straw man" technique of arguing, the straw man being an opponent you deliberately construct to be easy to knock down, hopefully destroying a strong argument by linking it to the straw man. Ms Lee says that if the EMH where true, there could be no bubbles. Clearly there are bubbles. And there are corrections, which to me shows that the market does catch up. Small investors should remember that plenty of people make money on bubbles, but there are plenty of losers when the crash happens, and from what I've seen, retail investors are the fall guys. Diversity is a sound course of action, and index funds are a cheap way to diversify.