In the past, the purpose of having a mutual fund manager was to have someone with an intimate knowledge of stocks and the economy choosing companies that should be invested in. Each mutual fund company was distinct in that they had their own approach and interpretation of the market cycle and size of the company that they would invest in. Within a certain category, like small cap stocks, a fund manager would decide which companies to own. Because the rule had always been to "diversify" away the risk, many different stocks would be selected in the event that a decline would come.
Unfortunately, as Americans appetite for investing grew it became clear that a large majority of mutual fund managers could not beat the major stock indexes. The logical question became, what is the point in investing in a fund that can't beat the index? Why not create a fund that does exactly what the index does instead? In response, the Vanguard Group created the S&P 500 index fund. This fund was intended to replicate the movement of the S&P 500 index by holding a proportional amount of stocks that mirrored the index with a minimal fee.
Initially, the idea of not trying to beat the index gained traction. After all, more than 70% of actively managed funds couldn't beat the least diversified index (Dow Jones Industrials) in any given year. In addition, 90% to 95% of managed mutual funds couldn't string together 3 years in a row of beating the S&P 5oo. Almost as a way to throw in the towel on the concept of managed mutual funds, a proliferation of index funds started to pop up.
Prior to the creation of the Vanguard S&P 500 Index fund, there was relatively few changes in the number of indexes in existence. After the creation of the S&P 500 Index fund there was a sudden jump in the number new indexes being created. Once an index was created an index fund was created to track that particular index. The goal was to have a fund that could track the index without having a manager make the decisions as to what to buy and sell. Of course, not even the new index funds could beat the indexes because there was the matter of "management" fees. After all, these things don't run themselves.
As I hinted at before, ETFs pose a tremendous risk to the stock market and the portfolios of the respective ETF will be remembered for the fact that due to a liquidity drain all the stocks held will collapse regardless of value. With little cash on hand and an "automated" form of management there will be a crash on the most liquid stocks because the relatively illiquid stocks won't be able register a bid.
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