TIME

In the Latest Issue

Chad Stover Football Time Magazine Cover
Photograph by Curtis Simmons/The Tipton Times

The Tragic Risks of American Football
Sixteen-year-old Chad Stover died playing a game after suffering a traumatic brain injury. Is the game worth it?

Rules of the Game

U2’s Mission to Save Music
Will giving away their new album help persuade consumers to value music again?

The Rise of Concealed Weapons in America
Why more people are walking around with guns hidden in their belts, bags and purses than ever before

Francois Hollande Fights Personal Scandal
France’s leader tries to contain political fallout after release of former partner’s book

John Kerry’s Wary Coalition
Will the U.S.’s shaky group of partners hold against ISIS?

The Triumph of Index Funds
CalPERS’ move is a vote for passive investing

Reading For Riches: Fall’s Big Business Books
From lessons on how to influence people to the future of the global economy, these titles are all on the money

The Science of Earning Respect

NASA’s New Big Winners
The space agency announces who will build its next orbital spacecraft

Bill Cosby’s Maddening Paradox
A new book explores America’s favorite TV dad

10 Questions With Ian McEwan
The author on wandering spouses, long lost brothers and that other Ian

How Much Salt Is Safe?
Warnings abound that we’re overloading on salt, but earlier in September a study found that sodium wasn’t significantly linked to high blood pressure in people who were not hypertensive. How to make sense of it all? Start here.

Tina Fey’s Family Drama
“This is Where I Leave You” is the kind of bet Holllywood doesn’t like to make anymore

Silence of the Liams
The stalwart Neeson stalks psychos in a grim, sadistic thriller

Shonda Rhimes Night in America
For three hours on Thursday, it’s OMG TV

Ten ‘Common Core’ Requirements for Teens
These won’t get teens into college, but will make them better people

The Pot Raiders
Private security pulls weed in an economy no longer quite underground

The Case for Staying Connected
We don’t need to ditch the grid. We need to fix the power business

Mojang, Creator Of Minecraft

Dark Clouds

Pop Chart

Briefing

World

Milestones

Robert Mueller
The former FBI director probing the NFL

Ian Paisley
Northern Irish unionist

TIME Investing

The Triumph of Index Funds

CalPERS’ move is a vote for passive investing

It would be reasonable to assume that the professionals running CalPERS, the California pension fund with $300 billion in assets, would be good at picking stocks. Or at least reasonably good at picking other smart people to pick stocks for them. But in the past year, CalPERS has made two decisions that are telling for all investors when it comes to trying to outperform the market.

Late last year, the pension fund signaled its intention to move more assets from active management into passively managed index funds. These are funds in which you buy a market, such as the S&P 500 or the Russell 2000, unlike mutual funds that try to select winners within a given class of equities. More recently, CalPERS said it would also pull out the $4 billion it has invested in hedge funds. Although hedge-fund honchos make headlines with their personal wealth, the industry has significantly lagged the market in the past three years. “Call it capitulation or sobriety: it’s saying that we can’t beat the market and we can’t find managers who can beat the market, and even if they can, their fee structures are overwhelming,” says Mitch Tuchman, CEO of Rebalance IRA, an investment adviser focused on index-fund-only portfolios.

The CalPERS move is a nod to University of Chicago economist Eugene Fama, who won a Nobel for his lifelong work on “efficient markets.” That theory says that because stock prices reflect all available information at any moment–they are informationally “efficient”–future prices are unpredictable, so trying to beat the market is useless. According to the SPIVA (S&P Indices Versus Active) Scorecard, the return on the S&P 500 beat 87% of active managers in domestic large-cap equity funds over the past five years.

Why can’t expert money managers succeed? Researchers from the University of Chicago say there are so many smart managers that they offset one another, gaining or losing at others’ expense and winding up near the market average, before expenses. “Unless you have some really special information about a manager, there’s really no good reason to put your money in actively managed mutual funds,” says Juhani Linnainmaa, associate professor of finance at Chicago’s Booth School of Business. He says the median managed fund produces an average –1% alpha–that is, below the expected return. Some funds do beat their index–what’s not clear is why. “What is the luck factor?” he asks. “Given the noise in the market, it’s kind of hopeless to try to figure anything out of this.” Linnainmaa’s colleague, finance professor Lubos Pastor, also found that mutual funds have decreasing returns to scale. Size hurts a manager’s ability to trade.

Yet even if managers match the market, they’ve got expense ratios that then eat into returns. Index-fund proponents like John Bogle at Vanguard have long preached that fees dilute performance. A 1% difference can be huge. “It’s not 1% of all your money,” says Tuchman, “it’s 1% of expected returns: that’s 16% to 20%.” The average balance in Fidelity 401(k) plans was $89,300 in 2013. While 1% of that is $893, if you earned 8% compounded over 10 years, your balance would be $192,792; at 7% it’s $175,667, a difference of $17,125. Real money, in other words.

Investors are getting the message, pouring some $345 billion into passive mutual and exchange-traded funds over the past 12 months vs. $126 billion in active funds, says Morningstar. “At the end of the day,” says Tuchman, “an index fund is run by a computer, a robot. We don’t want to believe that a robot can beat Ivy League M.B.A.s–and I’m one of them.” What CalPERS seems to be saying is that the game is over. The robot wins.

Your browser, Internet Explorer 8 or below, is out of date. It has known security flaws and may not display all features of this and other websites.

Learn how to update your browser