If investing seems hard then you make it too hard. It can be simple, and the simplicity relies on the form of investing in all stocks by using Index Funds.
People have been taught that mutual fund managers are the people that make the most money for you and can beat the market.
These managers may be able to do it one year, two years, or multiple years, but chances are their streak will end. If you want an easier, simpler solution, just buy it all in an index fund.
“Don’t look for the needle in the haystack. Just buy the haystack!” John Bogle.
The History of the Index Fund
In 1975, John Bogle created the brokerage company called Vanguard. He created the first Index Fund VFINX, which tracked the S&P500 Index.
The index fund would be a fund for people to invest in at rock bottom prices, buying the top companies in the U.S.A. and not have to be swindled by Financial Advisors selling high fee managed Mutual Funds. It was also a passive investment.
“The index fund is a most unlikely hero for the typical investor. It is no more (nor less) than a broadly diversified portfolio, typically run at rock-bottom costs, without the putative benefit of a brilliant, resourceful, and highly skilled portfolio manager. The index fund simply buys and holds the securities in a particular index, in proportion to their weight in the index. The concept is simplicity writ large.” John Bogle
What is an Index Fund?
An Index fund is a type of mutual fund. It works like a mutual fund except it tracks an index and it is not actively managed.
Being not actively managed creates some great things for the investor.
First of all, there will be less fees. There is no one to pay to manage the fund so the fees should be quite lower. John Bogle set out to create low-cost funds that benefited the investor instead of the broker.
Secondly, due to non management there are less taxes incurred. Managed funds can create many taxes that creates some drag on the returns.
Buying and selling the securities within the fund will incur unnecessary taxes that are put onto the investor.
With Index Funds, the funds are tracking all the securities within the index. There is no need to buy or sell the securities, and therefore there is less cash drag since there is less taxes. Higher returns means more money for the investor.
Since Index Funds are a type of mutual fund they will then work in a similar way. They will buy and sell at the price at the end of the day.
You can buy in with as much or as little as you would like. The investment can be automated by withdrawing money out of your account every month to be invested. It makes life simple and easy.
Index funds also seek to match the risk and return over the market. For the long term it should outperform any single investment.
Index Funds vs Managed Funds
Low Expense Ratio
Due to the nature of mutual funds there are costs that are associated with managing the funds. Since the Index Fund is passively managed and not actively managed the expense ratio is quite lower. The ratios can range from 0%-0.2%.
Compare that to an actively managed fund that has an expense ratio of 1-2.5%. The costs do not always match the returns. It is much better to have the low costs of the Index Fund than to hope that a manager will try to beat the market.
- Best Diversification
- Ideal for Buy and hold investors
- Low expense ratios
- Strong long term returns
- Prone to market swings
- No active investing
- Lack of Flexibility
Are the returns better?
During a five year period ending in December 2018, 82% of active mutual fund managers failed to beat the S&P500. It would have been much better to invest your money in a low-cost index fund like VFINX that tracked the S&P500.
The famous investor, Warren Buffett, made a bet of a million dollars with some Hedge Fund managers in 2007 that an index fund could outperform their Hedge funds in a 10 year period. In 2017, Warren Buffett won that bet.
Over time, with market swings and the unpredictability of the market, it is much better to invest in an Index Fund that tracks the market than to rely on a broker or an active manager of a mutual fund. The returns are much better.
Where can we buy Index Funds?
There are several online brokerages that you can choose from. My favorite being Vanguard, but there are others like Fidelity and Schwab as well that offer great index funds with low costs and great returns.
If these Index funds look too expensive you can venture off into ETFs that are made from the Index Funds.
VTSAX, which is Vanguard’s total Stock Market Index fund, has the ETF, VTI. It is possible to buy this ETF if you would like too.
There are also Robo Advisors that can help you invest in the index funds. Most Robo Advisors do not offer mutual funds, but you can buy the ETFs.
One of my favorite companies would be M1 Finance. They help make it automatic in buying ETFs and reinvesting any dividends you may receive.
Why look for the needle when you can buy the haystack. Index funds make investing boring, but simple and easy.
What are you waiting for? It is time to think smarter, not harder.
” Spend less than you make, stay out of debt, and invest the rest”
I’m Steve. I’m an English Teacher, traveler, and an avid outdoorsman. If you’d like to comment, ask a question, or simply say hi, leave me a message here, on Twitter (@thefrugalexpat1). Many of my posts have been written to help those in their journey to financial independence. I am on my journey, and as I learn more I hope to share more. And as always, thanks for reading The Frugal Expat.