Invest in Index Funds
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.