Are index funds really worth it?
Quick Answer
Over the long term, index funds have generally outperformed other types of mutual funds. Other benefits of index funds include low fees, tax advantages (they generate less taxable income), and low risk (since they're highly diversified).
Investing legend Warren Buffett has said that the average investor need only invest in a broad stock market index to be properly diversified. However, you can easily customize your fund mix if you want additional exposure to specific markets in your portfolio.
To build wealth in index funds, you need discipline, money, and time. It is easy to become a millionaire using index funds with all three ingredients but becoming one in 10 years means you have less time.
Disadvantages of index funds. While index funds do have benefits, they also have drawbacks to understand before investing. An index fund tends to include both high- and low-performing stocks and bonds in the index it's tracking. Any returns you earn would be an average of them all.
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.
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.
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.
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.
Indexes are set portfolios. If an investor buys an index fund, they have no control over the individual holdings in the portfolio. You may have specific companies that you like and want to own, such as a favorite bank or food company that you have researched and want to buy.
Why don t more people invest in index funds?
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.
The one time it's okay to choose a single investment
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.
Berkshire Hathaway CEO Warren Buffett has regularly recommended an S&P 500 index fund. The S&P 500 has been a profitable investment over every rolling 20-year period in history. The S&P 500 returned 1,800% over the last three decades, compounding at a pace that would have turned $450 per month into $983,800.
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).
| Index fund | Minimum investment | Expense ratio |
|---|---|---|
| Invesco NASDAQ 100 ETF (QQQM) | No minimum | 0.15% |
| Invesco QQQ (QQQ) | No minimum | 0.20% |
| Fidelity NASDAQ Composite Index Fund (FNCMX) | No minimum | 0.34% |
Exchange-traded funds (ETFs) and index funds are similar in many ways but ETFs are considered to be more convenient to enter or exit. They can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange.
Much of it, yes, but not entirely. In a broad-based sell-off of a market, the benchmark index will lose value accordingly. That means an index fund tied to the benchmark will also lose value.
The S&P 500, through index funds from the likes of Vanguard and SPDR, provides long-term returns that have historically outpaced inflation.
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.
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).
How much was $10,000 invested in the S&P 500 in 2000?
Think About This: $10,000 invested in the S&P 500 at the beginning of 2000 would have grown to $32,527 over 20 years — an average return of 6.07% per year.
| Symbol | Pct of portfolio | |
|---|---|---|
| Chevron Corp | CVX | 5.6% |
| Citigroup Inc | C | 0.9% |
| Coca-Cola Co | KO | 6.6% |
| Davita Inc | DVA | 1.3% |
Buffett's ultimately successful contention was that, including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years. The bet pit two basic investing philosophies against each other: passive and active investing.
| 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 |
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.
