I use broadly diversified, low cost index funds in my clients’ portfolios as well as in my own.

The reasons?

Sure, index funds have lower costs (expense ratios, bid-ask spreads, brokerage costs) than non-index funds.  And yes, index funds have less trading activity, or portfolio turnover, which results in less tax liabilities than non-index funds. These are generally accepted facts that most investors are aware of.

What you might not realize, however, is that index funds reduce uncertainty.  And this is the primary reason why I use them.

Allow me to explain . . .

Let’s say you have a non-index, or actively managed, fund.  And let’s assume that for a period of time the market goes up by 5%. And for purposes of this discussion, the period of time or how you define the “market” doesn’t matter one bit. So if the market is up by 5%, I know that if I use an index fund that tracks this market, it will be up by 5% less the costs of the fund.

But if I use a non-index fund, the performance could be anywhere.  It could “beat” the market and be up by more than 5% which actively managed fund promoters would like you to think happens more often than it actually does.  The actively managed fund could be up the same as the market (less costs, of course) or it could post a return for the same arbitrary time period that is much less than 5%.

And here’s the important part: no one knows how a non-index investment will perform ahead of time.

So given the choice between an investment that will always, for better or worse, match the market less expenses or an investment that could do better or worse than the market at any given time, I would argue that the index investment reduces another layer of uncertainty in the wealth management process.

I’m not saying index funds will outperform non-index funds, either.  They may or they may not. I don’t know if they will and neither do you.

But in my role as a financial advisor, I’m helping my clients make the most of their lives, and one of the ways I can help them do this is to reduce or eliminate as much uncertainty as possible.  My decision to use index funds doesn’t eliminate all financial uncertainty, but it removes one more unknown — how my (and my clients’) investments will perform relative to the markets.

Non-index funds hope to beat the market at the price of possibly underperforming the market. The fact that we’ll never know when the outperformance or underperformance will occur is one uncertainty I’m not willing to live with.

And I don’t think you should either.

Hope is not an investment strategy.