Here at The Motley Fool, we try to run a family-friendly operation. After all, we hope that many of your pre-teen and teen children and grandchildren read our offerings along with you, learning about investing and starting early, for maximum results. That's why I've saved this excellent quotation by index fund pioneer John Bogle for this article, keeping it out of the headline:
Beethoven could tell you how to write a symphony, but you can't write a symphony like Beethoven does. You can't copy, with any hope of success, a Beethoven or Buffett. You can copy Bogle at any moment of time. Just buy the damn index fund.
Meet John Bogle
Let's back up a bit, though, to establish just why you should care what John Bogle thinks. At age 85, he's the father of the index fund, an investment recommended by none other than Warren Buffett and a way for small investors to outperform the pros. He has also been referred to as "the conscience" of the mutual fund industry, frequently and publicly criticizing troubling industry practices.
Bogle founded The Vanguard Group in 1974, wanting to put investors' interests first by charging low fees and delivering solid results. He went against prevailing thoughts by championing passive "index" investing, and in 1976 he introduced the first index fund, which now goes by the Vanguard Index 500 (VFINX) name. It now holds close to $200 billion in assets.
What's so great about the quote?
So what's so valuable about the Bogle quotation? Well, it kind of tells you all you need to know about investing. Sure, it's good to read up on investing and personal finance and to understand how stocks and the market fluctuate and why crashes happen and how steep fees can erode your earnings and that great companies have sustainable competitive advantages and that fixed-rate mortgages can be better than adjustable-rate ones in low-interest rate environments. There's definitely a lot you can learn about the financial world, and much of it can help you save or make money.
But if you wanted a more secure financial future and could only handle one sentence of advice, this would be a great sentence to hear: "Just buy the damn index fund."
Even Superinvestor Warren Buffett would agree. In his 2013 letter to shareholders, he mentioned directions he's left in his will for assets he's leaving his wife:
My advice to the trustee couldn't be more simple: 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.) I believe the trust's long-term results from this policy will be superior to those attained by most investors -- whether pension funds, institutions or individuals -- who employ high-fee managers.
Why index funds?
It's hard to argue with the beauty of investing in index funds. They've been so successful that many firms now offer them, so be sure to focus only on low-cost ones. The Vanguard one is a great example, as its "expense ratio" (annual fee) is just 0.17%. (Typical managed mutual funds charge 1% or more per year.) You might alternatively go with an exchange-traded fund (ETF) such as the SPDR S&P 500 ETF (NYSEMKT:SPY), which charges just 0.09% per year. Both recently yielded about 1.9% -- which makes sense, as both are invested in the same 500 stocks. The components of the S&P 500 index, it's worth noting, aren't just a modest subset of America's thousands of publicly traded companies. They're so large, in general, that together they make up about 80% of the market's total value.
Clearly, index funds are cheap. They're also convenient, and risk-reducing. With one simple transaction, you can be invested in 500 companies. That pretty much removes any risk of one holding imploding and taking your portfolio down. The 500 companies are weighted by market size, so with Apple's market capitalization recently surging past a remarkable $700 billion, close to twice its nearest counterpart, it does have an outsized influence on the fund, recently making up around 3.9% of its value.
If you're thinking that investing in index funds is a bit of a compromise in the investing world, and that you'll be giving up a chance of amazing returns, think again. Yes, if you invest in individual companies you carefully select, you might outperform the index. But guess what – most of the well-trained pros on Wall Street haven't been able to do so. Managed mutual funds routinely underperform the S&P 500. And over many decades, it has averaged annual gains of about 10%.
As Bogle has quipped: "Don't look for the needle. Buy the haystack."