For my money, there’s no beating index funds.
More important, than my money, for my sanity, there’s no beating index funds.
In today’s post, I want to highlight 7 things I love about index funds.
My 7 reasons range from the low costs and automatic diversification to the minimal mental effort required for long-term wealth.
If you’ve been a consistent reader of the blog, you know that money is as much emotional as it is rational. I don’t want to be worried about my money any more than you do.
That’s why the reasons I love index funds take into account both the numbers and the emotions of investing.
Let’s dive in.
7 Things I Love About Index Funds
- Anybody can do it
- No wasted mental energy
- Low fees
- Automatic diversification
- The closest thing to predictability
- I don’t have stock FOMO
- Good enough for Buffett, good enough for me
1. Anybody can do it
I’ve said it before, and I’ll say it again:
Investing is actually the easy part.
And, when I say investing is actually the easy part, I’m talking mostly about investing in index funds.
You don’t need an MBA or a financial background. You don’t need to read the Wall Street Journal.
All you need to do is consistently fuel your investment account and to let compound interest work its magic.
Oh wait, one more thing:
You also need to read Think and Talk Money. I post three times every week.
Oh, and tell your friends about Think and Talk Money!
2. No wasted mental energy
It goes without saying that most professionals are busy people. On top of working our day jobs, we’re also doing our best to stay healthy, be good family members, and have some semblance of a social life.
Some of us even have side hustles that occupy our time and mental energy.
The last thing we need is another stressor in our lives, like actively trading stocks.
I invest in index funds to take this stressor out of my life.
Yes, I could pay someone a lot of money to manage my money for me.
Or, I could invest in index funds and rest comfortably knowing that I’m going to be in great financial shape down the road.
Why am I confident I’m going to be in great financial shape?
For three main reasons, discussed next.
3. Low fees
Because index fund are passively managed, the fees are significantly lower than actively managed mutual funds.
My favorite index fund is Vanguard’s popular fund called the Vanguard Total Stock Market Index Fund (VTSAX). This fund currently charges .04%, which is just about the lowest fee you will ever see.
Compare that to the 1% fee commonly charged by investment advisors. Also, don’t forget it’s very difficult for even the professionals to beat the returns consistently generated by the S&P 500.
If you don’t think that difference in fees matters, check out my post on what a 1% fee really costs you:
While I can’t control what returns I may earn, I can control the fees I pay.
I’d rather pay .04% than 1%.
That’s especially true when there’s no guarantee that an advisor can perform better than the returns I earn through index funds.
4. Automatic diversification
By investing in an index fund, like an S&P 500 index fund or a total stock market index fund, my stock portfolio is by definition diversified.
For example, when I invest in an S&P 500 index fund, I essentially own a piece of 500 large companies.
Some companies may go up in value, others may go down. I’ll never know which ones are going to make money or lose money. By investing in an S&P 500 index fund, it doesn’t matter. I’m covered either way.
That’s the point of diversification: smooth out the ride so I’m less susceptible to the fortunes of one particular company.
As another example, I also invest in Vanguard’s total stock market index fund (VTSAX). This fund offers exposure to nearly the entire U.S. stock market, which consists of 3,598 companies.
Now, that’s really good diversification.
5. The closest thing to predictability
The S&P 500 has historically earned an average annual return of 10%.
By investing in an index fund that tracks the S&P 500, like I do in my 401(k), I have a pretty good chance of earning consistent returns in the long run.
Sure, there may be ups and downs.
But, check this out:
Since 1996, the S&P 500 has ended the year in positive territory 23 times and negative territory only 7 times.
In other words, the S&P 500 has generated positive returns three times more frequently than it generates negative returns.
And even with those 7 negative years, with the exception of 2000-2002, the S&P 500 returned to positive territory the following year.
What this all means is that while the S&P 500 will drop occasionally, the down periods are historically short-lived.
Because of this historical consistency, index funds give me the best shot at predictability.
Note that predictable returns does not mean guaranteed returns. There are no guarantees in the stock market. That’s why my preference is predictability.
I’m very happy with consistent returns and a smoother ride.
6. I don’t have stock FOMO
Depending on the index fund you choose, you may own pieces of a handful of companies or as many as 3,598 companies.
I invest in S&P 500 index funds and total stock market funds. That means I own pieces of lots of companies.
It also means I never have stock FOMO.
You know what stock FOMO is, right?
Stock FOMO is when you find yourself in a conversation talking about something fun like your favorite new show. Then out of nowhere, someone volunteers the hot stock he bought that’s up 20%.
If you have stock FOMO, you feel like you’re missing out by not owning that stock. You think to yourself, “Oh man, that guy’s going to be so rich and I missed the boat!”
You might even run back to your desk so you can buy that hot stock, not realizing that you’ve probably already missed the train.
Stock FOMO can cause a lot of stress. I don’t want that stress.
So, I invest in index funds.
When a stock jumps 20%, I feel good because I already own every company in the U.S. stock market.
No stock FOMO here.
7. Good enough for Buffett, good enough for me
In 2013, Buffett famously instructed that after he dies, his wife’s cash should be split 10% in short-term government bonds and “90% in a very low-cost S&P 500 index fund.”
Good enough for Buffett, good enough for me.
It’s not just Buffett, though. One of my favorite authors on investing, J.L. Collins, wrote about the advantages of investing in a total stock market index fund in his seminal book, The Simple Path to Wealth.
In fact, Collins makes a compelling argument that the Vanguard Total Stock Market Index Fund (VTSAX) we discussed above may be the only stock fund that you’ll ever need.
Buffett and Collins are smart guys. Taking advice from smart guys seems like a good idea to me.
I highly encourage you read The Simple Path to Wealth.
What do you think of the 7 things I love about index funds?
To recap, I love index funds for these 7 reasons:
- Anybody can do it
- No wasted mental energy
- Low fees
- Automatic diversification
- The closest thing to predictability
- I don’t have stock FOMO
- Good enough for Buffett, good enough for me
My reasoning combines the emotional side and the rational side of investing.
Like you, I want to earn a nice investment return. At the same time, I don’t want to be worried about my investments 24-7.
Index funds give me the best of both worlds.
What am I missing?
Help me grow my list of 7 into a list of 10 by leaving a comment below on why you invest in index funds.
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