Index Fund Investing

Index fund investing offers broad market exposure at low cost. It's recommended by Warren Buffett and has beaten most active managers over long periods. [DEFINITION] Index Fund: A mutual fund or ETF designed to track the performance of a specific market index (like the S&P 500) by holding all or most of its components. ### Why Index Funds Win **The data is overwhelming:** - 90%+ of active managers underperform their benchmark over 15+ years - Fees compound negatively over time - Index funds offer guaranteed "average" returns (which beat most) [KEY] You don't need to beat the market—matching it is enough to build significant wealth and puts you ahead of most investors. ### Benefits of Index Investing **Low costs:** - Expense ratios often 0.03-0.10% - No trading costs from turnover - Tax efficient (low capital gains) **Diversification:** - Own hundreds or thousands of stocks - Sector and company-specific risk reduced - No single stock can hurt you badly **Simplicity:** - No stock picking required - No market timing needed - Set and forget [EXAMPLE] $10,000 invested at age 25 in S&P 500 index fund growing at 10% annually becomes ~$450,000 by age 65. With 1% active management fees, only ~$340,000—fees cost you $110,000! ### Types of Index Funds **Broad market:** - S&P 500 (VOO, SPY, IVV) - Total US Market (VTI, ITOT) - Total World (VT) **Sector specific:** - Technology (VGT) - Healthcare (VHT) - Real Estate (VNQ) **Factor-based:** - Value (VTV) - Growth (VUG) - Dividend (VYM) ### Building an Index Portfolio **Simple three-fund portfolio:** 1. US Total Stock Market (60%) 2. International Stock Market (30%) 3. US Bond Market (10%) Adjust bond allocation higher as you approach retirement. [TIP] "Bogleheads" (followers of Vanguard founder John Bogle) have popularized this simple, effective approach. Most investors need nothing more complex. ### Index Fund Limitations [WARNING] Index funds aren't perfect: - You own everything (good and bad companies) - Can't avoid overvalued sectors - Performance tied to market (no outperformance possible) - Still lose money in bear markets ### ETF vs. Mutual Fund **ETFs:** - Trade intraday like stocks - Usually lower minimums - More tax efficient - Good for: Taxable accounts, small amounts **Mutual Funds:** - Trade once daily at NAV - May have minimums ($1,000-$3,000) - Easy automatic investment - Good for: 401(k)s, large regular investments [FORMULA] True Cost = Expense Ratio + Trading Costs + Tax Drag + Opportunity Cost of Cash [EXERCISE] You have $50,000 to invest for 30 years. Option A: S&P 500 index fund (0.03% expense ratio). Option B: Actively managed fund (1.0% expense ratio). Assuming both return 8% before fees, what's the difference after 30 years? |ANSWER| Option A: $50,000 × (1.0797)^30 = $497,000. Option B: $50,000 × (1.07)^30 = $380,000. The 0.97% fee difference costs you $117,000—or 24% of your wealth! [SCENARIO] A friend says, "Index funds are boring. I want to pick stocks and beat the market." How would you respond? Share the data: 90%+ of professionals fail to beat their index long-term. If the pros can't do it, what are the odds for an amateur? Stock picking is entertainment, not investment strategy. By all means, allocate 5-10% to individual stocks for fun, but put the core portfolio in index funds. Your future self will thank you.