You may be a new or new-ish investor wondering where to park a chunk of money. You may be a seasoned investor doing the same. Both kinds of investors should consider investing in one or more index funds -- because index funds have a lot to offer.
An index fund is a mutual fund or exchange-traded fund (ETF) that holds just about all of the same securities as a particular index does, in similar proportions to the index's weighting. It's thereby built to deliver roughly the same performance for investors as the index it tracks -- minus its fees. Here are five reasons why index funds can serve you very well.
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1. Set it and forget it -- no market savviness required
First off, index funds offer simplicity and ease. If you're a typical investor who has a portfolio of individual stocks, there's a good chance that you spend a lot of time keeping up with the companies in which you're invested, reading their quarterly and annual reports and following them in the news. (At least, those are things that most investors in individual stocks should be doing.)
Such investors will also spend time deciding if and when it's time to sell any of their holdings, and sifting through the universe of stocks to find new investments. This can be fun for certain folks; for others, it will feel like onerous work.
None of that work is required with regards to the dollars you park in outstanding index funds -- though, ideally, you should keep adding more dollars to those holdings over time.
2. Instant diversification
When one of your individual stock holdings suddenly soars, it can be quite a rush. But every year, plenty of stocks will crash. You never want to have too much of your money in any one stock, unless you're extremely confident that it won't let you down. Our Foolish investing philosophy suggests that investors diversify by buying 25 or more different stocks, and hanging on to them for at least five years. Index funds offer an even greater degree of diversification in a single investment. Park some dollars in, for example, an S&P 500 index fund, and your money will be spread across 500 of the biggest U.S. companies.
3. Indexes can be strong growers
Don't think that opting for index funds is any kind of compromise, dooming you to sub-par growth: Over long periods, index funds have performed very well, trouncing their actively managed counterparts (funds where professional stock pickers choose what to buy and sell). For example, fully 95% of all large-cap stock mutual funds underperformed the S&P 500 index over the 20-year period that ended in 2022, per data from S&P Global.
The overall stock market has averaged annual gains of close to 10% over many decades, so it's not unreasonable to hope for average annual gains of 8% during your particular decade or three of investing. Here's how much money you might amass over time at that growth rate.
|
Growing at 8% for... |
$7,000 Invested Annually Becomes... |
$15,000 Invested Annually Becomes... |
|---|---|---|
|
5 years |
$44,351 |
$95,039 |
|
10 years |
$109,518 |
$234,682 |
|
15 years |
$205,270 |
$439,864 |
|
20 years |
$345,960 |
$741,344 |
|
25 years |
$552,681 |
$1,184,316 |
|
30 years |
$856,421 |
$1,835,188 |
|
35 years |
$1,302,715 |
$2,791,532 |
|
40 years |
$1,958,467 |
$4,196,716 |
Source: Calculations by author.
See? Those results are quite good, and not easily matched by investing in anything other than index funds. (Yes, you might well surpass them via individual stocks, but your customized, personally managed portfolio can also underperform.)
4. They tend to charge ultra-low fees
Another great thing about index funds is that the best of them sport ultra-low annual fees. A typical actively managed mutual fund may charge around 1% annually, but the best index funds charge less than 0.2%, and some charge less than 0.1%.
Those differences may not seem that meaningful, but they can help you keep tens of thousands of dollars more in your pocket over decades.
5. Even Warren Buffet loves index funds
Finally, know that even super-investor Warren Buffett is an index fund fan. He noted in his 2013 letter to Berkshire Hathaway shareholders that his will specifies how he wants the money he leaves for his wife to be invested: "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)" Further, in a 2017 CNBC interview, Buffett noted that a low-cost S&P 500 index fund is the kind of investment "that makes the most sense practically all of the time."
So don't ignore the power and ease of index funds, and don't assume that they will give you lackluster returns. Instead, give serious thought to parking some or all of your long-term dollars in one or more index funds.
