Index funds give investors a simple way to make money in the financial markets. I've recommended them for more than a decade, and I'm not alone.
According to Warren Buffett, "By periodically investing in an index fund … the know-nothing investor can actually out-perform most investment professionals." Buffett has stressed that basic investors who aren't savvy about stocks should just invest regularly in a large number of stocks over a period of time.
He's even put his money where his mouth is, betting a $1 million donation to charity that the Vanguard S&P 500 Index (VFINX) fund will outperform a handful of respected hedge funds over the coming decade.
So is there any reason to go beyond a simple S&P 500 index fund? The 500 companies in the index are so big that together, they still make up roughly 75% of the market's total value. And with stocks like UnitedHealth Group (NYSE:UNH), Coca-Cola (NYSE:KO), and Amazon.com (NASDAQ:AMZN) among the index's components, you'll get exposure to many of the world's leading companies.
But hold on ...
A key idea behind owning index funds is that you get to invest widely in one fell swoop. But there are limitations to the S&P 500. It contains most of the biggest American companies, yes, but it excludes thousands of smaller ones, which can outperform large caps. So if you really want to capture the whole U.S. market, you might want to opt for a total market index fund, such as the Vanguard Total Stock Market Index (VTSMX) fund, which will incorporate stocks like Visa (NYSE:V) that haven't made it into the S&P 500.
Then again, even the total stock market index still excludes foreign companies -- and ours is not the world's fastest-growing economy. By investing globally, we can profit as second- and third-world economies move up the ladder. Thus, you might also want to look at global index funds such as the Vanguard Total World Stock Index (VTWSX) fund. It includes thousands of big foreign companies such as BP (NYSE:BP), Toyota (NYSE:TM), and Novartis (NYSE:NVS).
Building a strong portfolio doesn't have to be hard. If you pick wisely, you can do it with just a few index funds.
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