Virtues of Index Funds

Mar 25, 2013 by

New York Stock Exchange

Fund fees help pay the rent on this place. Why contribute?

The following is a guest post by Josh Ziering of FutureAdvisor.

If you’re not investing in index funds, you’re missing out on a well diversified way to grow your money.

Index funds are collections of equities put together, and then sold as a homogenization. For example, let’s say you’re bullish on pants. Instead of trying to pick “Winner” pants companies, you bought one share of each company, and looked at their performance as a collective. That would be a pants index fund. Index funds are a great way to invest in a lot of companies at once.

Modern index funds can include lots of different companies. For example the Vanguard 500 is an index of the 500 most valuable publicly traded companies. You can buy shares in this index fund and you’ll own little tiny pieces of all 500 companies. The S&P 500 on which the fund is based grew by 12% last year . So, if you had $100 invested, you’d have $112 now.

Index funds are valuable in another way as well. Actively managed funds have to pick “winners” and in order to do that, they must pay people to pick those winners. They charge fees to cover these costs. These fees can be anywhere from 1-3% of your total investment. Most people ignore this fact, and don’t look at the math.

The S&P grew by 12% last year. Let’s assume our “winner pickers” charge 2% for their services. They would have to get returns of 14% just to match the performance of the S&P 500 index fund. And they have to have better returns than the S&P 500 year after year. That’s not an easy task when you start out 2% behind the curve. Since index funds are just a collection of companies, they don’t take a lot of horsepower to manage. The Vanguard S&P 500 index fund charges just .17% to manage.

If you don’t have any index funds in your portfolio, or worse yet, don’t know what’s in your portfolio, it’s time to investigate. You may be paying exorbitant fees in funds that are losing money. While it may not be as fun as a night out dancing, managing your retirement is far more important. Make sure it’s setup right, and then leave your money alone to grow while you’re dancing.

Comment by Kurt: I agree with Josh: Actively managed mutual fund fees will slash an investment’s performance. Read my post “Fund Fees: Nest Egg Killer” to see the dollars & cents numbers. You may be shocked by how much you’re paying for, in my opinion, nothing.

Josh is an index investing evangelist at FutureAdvisor, a digital financial advisor. He champions smart investing with academically backed principles. Wonder how your 401k plan stacks up? Check out our 401k plan index to find out!
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  • John S @ Frugal Rules

    Good post! I would agree, generally, that investing in index funds can be a great way to go if you’re investing in the stock market. I think this is especially the case if you lack the time or experience investing and want something that you an stick with.

    • http://mymoneycounselor.com/ Kurt @ Money Counselor

      Amen. Index fund investing is more of a “set it and forget it” strategy than others that require more knowledge and attention.

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