In 2007, legendary investor Warren Buffett made a $1 million bet with a Wall Street hedge fund firm. He wagered that a simple, unmanaged S&P 500 index fund would outperform their complex, highly-managed portfolio of hedge funds over a ten-year period. By 2017, the results were in: Buffett’s boring index fund crushed the Wall Street experts, earning a 7.1% annualized return compared to their 2.2%.

How does a computer algorithm buying every stock blindly beat Ivy League analysts working 80 hours a week? The answer lies in the math of index funds.

What is an Index Fund?

Instead of hiring an expensive manager to try and pick “winning” stocks, an index fund is programmed to simply buy and hold all the stocks in a specific market index. The most famous is the S&P 500, which consists of the 500 largest publicly traded companies in the United States (Apple, Microsoft, Amazon, etc.).

When you buy an S&P 500 index fund, you instantly own a tiny fraction of the 500 most powerful companies in America. You are not betting on a single horse; you are buying the entire racetrack.

Reason 1: The Impact of Fees

The primary reason index funds win is their insanely low cost. Actively managed mutual funds employ teams of analysts, trade frequently, and spend millions on marketing. They pass these costs to you via an “Expense Ratio,” often charging 1% or more of your total investment every single year, regardless of whether the fund makes or loses money.

Index funds are run by algorithms. They don’t need analysts. Therefore, their expense ratios are virtually zero (often around 0.03%). Over a 30-year investing horizon, that 1% difference in fees can literally rob you of hundreds of thousands of dollars in compound growth.

Reason 2: The Difficulty of Stock Picking

It is statistically nearly impossible to consistently pick winning stocks year after year. The market is incredibly efficient; by the time you hear good news about a company on CNBC, that news is already priced into the stock.

Studies consistently show that over a 15-year period, more than 85% of actively managed funds underperform their benchmark index. If the highly-paid experts on Wall Street can’t beat the market, your chances of doing it in your spare time are abysmal.

Reason 3: Self-Cleansing Portfolios

An index fund like the S&P 500 is naturally self-cleansing. If a company begins to fail and its value drops, it eventually falls out of the top 500 and is removed from the index. It is replaced by a rising, successful company.

Without you having to read a single financial report, your portfolio automatically weeds out the losers and buys the winners. You are guaranteed to capture the overall growth of the American (or global) economy.

Conclusion

Investing should be boring. It shouldn’t involve frantic day trading, analyzing candlestick charts, or agonizing over quarterly earnings reports. By investing in index funds, you accept “average” market returns—but because you avoid high fees and the massive mistakes of active trading, your “average” return will mathematically place you ahead of the vast majority of investors.