Are index funds better?
Lower costs: Index funds typically have lower expense ratios because they are passively managed. Market representation: Index funds aim to mirror the performance of a specific index, offering broad market exposure. This is worthwhile for those looking for a diversified investment that tracks overall market trends.
Individual stocks may rise and fall, but indexes tend to rise over time. With index funds, you won't get bull returns during a bear market. But you won't lose cash in a single investment that sinks as the market turns skyward, either. And the S&P 500 has posted an average annual return of nearly 10% since 1928.
Index funds are popular with investors because they promise ownership of a wide variety of stocks, greater diversification and lower risk – usually all at a low cost. That's why many investors, especially beginners, find index funds to be superior investments to individual stocks.
Tracking error may occur in an index fund due to liquidity provisions, index constituent changes, corporate actions etc. This is a major risk in index funds. Index funds do lose out on the expertise of the fund manager and the structured investment approach that an active fund manager brings.
The average stock market return is about 10% per year, as measured by the S&P 500 index, but that 10% average rate is reduced by inflation.
It's easy to see why S&P 500 index funds are so popular with the billionaire investor class. The S&P 500 has a long history of delivering strong returns, averaging 9% annually over 150 years. In other words, it's hard to find an investment with a better track record than the U.S. stock market.
If you're new to investing, you can absolutely start off by buying index funds alone as you learn more about how to choose the right stocks. But as your knowledge grows, you may want to branch out and add different companies to your portfolio that you feel align well with your personal risk tolerance and goals.
All investments carry risk. An index fund, like anything else, can potentially lose value over time. That being said, most mainstream index funds are generally considered a conservative way to invest in equities (although there are lesser-known index funds that are thought to carry greater risk).
Because the goal of index funds is to mirror the same holdings of whatever index they track, they are naturally diversified and thus hold a lower risk than individual stock holdings. Market indexes tend to have a good track record, too.
Another reason some investors don't invest in index funds is that they may have a preference for investing in a particular industry or sector. Index funds are designed to provide exposure to broad market indices, which may not align with an investor's specific interests or values.
Why doesn't everyone just invest in S&P 500?
That's because your investment gives you access to the broad stock market. Meanwhile, if you only invest in S&P 500 ETFs, you won't beat the broad market. Rather, you can expect your portfolio's performance to be in line with that of the broad market. But that's not necessarily a bad thing.
For beginners, the vast array of index funds options can be overwhelming. We recommend Vanguard S&P 500 ETF (VOO) (minimum investment: $1; expense Ratio: 0.03%); Invesco QQQ ETF (QQQ) (minimum investment: NA; expense Ratio: 0.2%); and SPDR Dow Jones Industrial Average ETF Trust (DIA).
The concept of the "safest investment" can vary depending on individual perspectives and economic contexts, but generally, cash and government bonds, particularly U.S. Treasury securities, are often considered among the safest investment options available. This is because there is minimal risk of loss.
In 1980, had you invested a mere $1,000 in what went on to become the top-performing stock of S&P 500, then you would be sitting on a cool $1.2 million today.
Index mutual funds & ETFs
Constant buying and selling by active fund managers tends to produce taxable gains—and in many cases, short-term gains that are taxed at a higher rate.
Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks. And as we saw, the chances of getting positive returns improve when you give time to your investments.
Buffett not only sees index funds as the simplest path to achieve a diversified portfolio, but they're also the cheapest. One of the biggest factors that drives down the performance of mutual funds are the fees investors have to pay. That's led 92% of active mutual funds to underperform the market over the long run.
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
Warren Buffett Portfolio | ||
---|---|---|
All time Stats (Since Jan 1871) | Return | +8.75% |
Std Dev | 14.85% | |
Max Drawdown | -79.29% | |
Last Update: 31 March 2024 |
- Vanguard S&P 500 ETF: 0.03%
- Vanguard Large-Cap ETF: 0.04%
- Schwab U.S. Large-Cap ETF: 0.03%
- Vanguard Mid-Cap ETF: 0.04%
- Schwab U.S. Mid-Cap ETF: 0.04%
- Vanguard Small-Cap ETF: 0.05%
- iShares Core S&P Small-Cap ETF: 0.06%
- Schwab U.S. Broad Market: 0.03%
Are index funds safe during recession?
The important thing to remember about index funds is that they should be long-term holds. This means that a short-term recession should not affect your investments.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Asset prices can rise and fall rapidly and investors must accept the fact that the value of their index based investment may fluctuate by as much as 50% or more in a year. General market risk can relate to a particular sector. For example, mining sector indices are usually more volatile than industrial sector indices.
For example, if you are able to commit to investing $500 a month in an S&P 500 index fund like the Vanguard 500 Fund (NYSEMKT: VOO), you'll eventually have $1 million, and that includes paying the 0.03% expense ratio in the ETF, meaning you'll pay 3 cents each year for every $100 you have invested in the index fund.
Vanguard is paid by the funds to provide administration and other services. If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
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