SEC Fraud

When it comes to investing, there are two general and common mistakes that the average person often makes. The first mistake is that they buy and sell their stocks at inopportune times, a problem that leads many to sell low and buy high. The second is that many people don’t even have market investments in the first place. When asked to explain why, they will often reply that they don’t understand enough, that they are too indecisive to build a portfolio, or that they simply find the complex world of mutual funds, short-selling, dividend reinvestment, and internet banks too intimidating for their comfort. This second mistake scares people out of the stock market and prompts them to put their money in far less profitable bonds and saving accounts.

My solution to both of these common mistakes is a simple one: index funds. Of all the investment opportunities out there, index funds are some of the safest, cheapest, easiest, and most profitable. There’s not much not to like. Unlike mutual funds they have minimal fees and low penalties. Unlike individual stock purchases they offer instant diversification by immediately exposing a portfolio to a wide range of companies and industries.

While diversification and low fees may appeal to all types of investors, index funds are uniquely suited to the needs of the most inexperienced and amateur ones out there. For one thing they are easy to track; if you own an S&P 500 index fund, you simply need to open the paper or turn on the news in the morning to see how your investment performed the previous day. Index funds also lower capital gains charges that can pose headaches for the inexperienced investor come tax season. And, of course, they insure that you’ll never have to worry about the diversification of your portfolio. All of these add up to one crucial long-term benefit: unlike with other investments, there is little reason to actively buy or sell index funds. Once the investor has an index fund in his portfolio, he can sit back, take any volatility in stride, and let it grow for several decades.

Of course, an index fund by its very nature cannot beat the overall market and cannot insure one against massive economic volatility. But such volatility would likely affect every other investment vehicle, and studies have shown that it is very rare for even an expert investor to beat the market in the long-run. It is thus the rare investor who will not benefit long-term by buying an index fund. If you’re intimidated by the market or get anxious whenever your stocks decline, an index fund might be just the answer to your investing woes.

John Bogle, founder of The Vanguard Group, believes in index fund investing. Warren Buffett, one of the pre-eminent investors of our time, advocates index funds for the average investor. The Motley Fool estimates that the vast majority of actively managed funds do not beat index funds (they say the market but for all intents and purposes, index funds are the market). Two of our generations’ most brilliant investment minds and one of the most well known and well respected financial sites in the world all advocate the simplest investment vehicles out there, but that alone isn’t a good reason to do it. Why should you invest in index funds?

They Are Cheap

Index funds are passively managed, meaning a manager isn’t heading up a large research group trying to figure out which investments to make. Index funds match the investments and percentages of their associated index and do so quite cheaply. The Vanguard 500 Index (VFINX) is Vanguard’s S&P 500 tracking index and it has an expense ratio of 0.15%. The Fidelity Spartan 500 Index (FSMKX) has an expense ratio of 0.10%. The expense ratio of an actively managed fund can range anywhere from 1-2%. That’s a significant difference especially if you consider each percent will erode your investments growing potential.

They Are The Benchmark

Think of all the actively managed mutual funds… so many are benchmarked against one index or another. The S&P 500 is the most popular but you’ll see the Russell 2000 or other popular indices from time to time. The Motley Fool, in studying empirical data, has seen that most actively managed funds don’t beat their benchmarks and often don’t beat the market. So, why not take the sure thing? Those index funds will get market returns minus the fees, which for the Vanguard 500 Index is 0.15% and the Fidelity Spart 500 Index is a mere 0.10%. Over the long haul, those dependable guaranteed returns of the market,

More Tax Efficient

Actively managed funds trade often and so they are not as tax efficient at index funds. Index funds tend to change only when the index itself changes, which doesn’t happen very often. Fewer trades mean fewer capital gains and losses, which means lower taxes. The bottom line is that you keep more of your gains.

The advantage that actively managed funds do give you is a chance to beat the market. Index funds will, by definition, never ever beat the market on their own. They will always give you market returns minus the fee, so it is mathematically impossible for you beat the market with an index fund.