When I began my career in the 1980s mutual funds advertised good performance and their insightful portfolio managers. Some managers (Peter Lynch, for one) became celebrities. At that time "low cost" funds were those without sales charges (called "loads"). Indexing was in its infancy. People thought it was crazy to own only an index rather than have a manager pick attractive stocks or do so themselves. That was then.

The debate over active versus passive management appears to be over. Thanks to their low fees index funds have outperformed most of their actively managed peers. According to Morningstar, index funds hit $4.27 trillion in assets, giving them more money than their stock-picking rivals for the first time ever.

That wouldn’t have happened unless the market was efficient, or nearly so. If analyzing a stock’s bullish fundamental or technical picture automatically would lead to outperformance, then actively managed funds would do better. But if the analysis doesn’t lead to better decisions, then it’s best to keep costs minimal. That’s where Vanguard comes in.

Vanguard is the market leader in index funds. Since the funds simply track an index, they can have extremely low fees. Vanguard’s S&P 500 Exchange-Traded Fund only charges 0.03 percent annually. Other ETF providers like Schwab, SPDR, and iShares have joined the low-fee race. 

Of course, just because you own passively managed funds doesn’t make you a passive investor.  ETFs provide the flexibility to easily invest in specific areas of the market. Momentum investors can buy the strongest areas, currently iShares Home Construction (ITB) and believe it or not Utilities Select SPDR (XLU). Investors can profit from the recent shift to value stocks by owning iShares S&P 500 Value (IVE). And the extremely liquid S&P 500 SPDR (SPY) allows traders to easily jump into and out of the market. Of course, that game is easier said than done. 

All this doesn’t mean that individual stocks shouldn’t be part of your portfolio. In my managed accounts, I hold both index ETFs and individual stocks. For clients seeking income, I’m happy to own Verizon (VZ) and AT&T (T). I’m also overweighting healthcare by owning stocks like Merck (MRK) and Amgen (AMGN).

By holding a combination of individual stocks (no cost of ownership) along with some low-cost index funds, an investor can build an attractive portfolio that overweights specific sectors while avoiding areas that are less attractive. And all that can be done while paying very little in fees. That is to our advantage.