WE STILL AREN’T THROUGH with these relentless rules
of humble arithmetic—the logical, inevitable, and unyielding long-term penalties assessed against stock market participants by investment expenses and the powerful impact
of inflation—that have slashed the capital accumulated by
mutual fund investors. As described in Chapter 4, the
index fund has provided excellent protection from the
penalty of these costs. While its real returns also were
hurt by inflation, the cumulative impact was far less than
on the actively managed equity funds.
But there is yet another cost—too often ignored—that
slashes even further the net returns that investors actually
receive. I’m referring to taxes—federal, state, and local income taxes.* And here again, the index fund garners a
substantial edge. The fact is that most managed mutual
funds are astonishingly tax-inefficient, a result of the short term focus of their portfolio managers, usually frenetic
traders of the stocks in the portfolios they supervise.
