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  • Writer's pictureZachP

#82. Adulting Is Hard: What Is An Index Fund?


Index funds are one of the greatest gifts to the average investor in the last 60 years. They allow you to beat most professional investors by only spending a couple of hours a year thinking about your investments.


If this is true, why doesn't everyone use them???


Well, let's look at the backstory of index fund investing first.


Background


It all started with John (aka "Jack") Bogle and him having a crazy idea. His thought - why not create a fund that follows the S&P 500 for the average investor?


The S&P 500 is a stock market index that tracks the 500 largest companies in the U.S. This index is the benchmark for many investors.


What is a benchmark? For an investor to be considered "good" at their job, they aim to beat their benchmarks. Thus, many stock market investors always try to beat the S&P index and its annual average return of roughly 10% year after year.


The problem? Most people (including many professionals) cannot beat the index!


Jack Bogle realized this issue and solved the problem. So, in 1976, he created a low-cost fund for the average investor that mimicked the returns of the S&P 500.


Oh, and did I mention Jack Bogle was the founder of Vanguard, one of the largest investment firms in the U.S.?


More On Low-Cost Index Funds


There are many types of low-cost index funds, including funds that track the S&P (SWPPX), the U.S. total stock market (VTSAX), the international market (VTIAX), and the bond market (FXNAX).


Most big investment firms also have low-cost target retirement index funds that track the major indexes and do the diversification between U.S. stocks, international exposure, and bonds for you.


I am a huge fan of target retirement index funds for those investors who only want to answer two questions: 1) When do I want to retire? 2) How much am I able to invest per month?


If anyone wants to keep their investing that simple, it is worth looking into these low-cost target retirement index funds.


"What About These ETFs I Hear About?"


ETFs stand for "exchange-traded funds". There are many ETFs that act very similar to low-cost index funds, such as VTI through Vanguard.


ETFs are also great for index fund investors and may provide better tax treatment in a normal taxable brokerage account.


Most people should not lose any sleep between choosing between an ETF or a low-cost mutual fund, as long as what they choose tracks a major index. Both can be great options. Just do some research first and find out what you are comfortable with.


What's The Catch?


There is always a catch, and index fund investing is no exception.


Index investors MUST have a long-term mindset that is able to ignore bear markets, bull markets, and even recessions.


No one can guarantee future performance, but we can look to the past for guidance. As I mentioned in my previous article, the S&P 500 has an average annual return of roughly 10%.


Take note - this is the annual average return. This means the stock market has down years, but, historically, has always recovered and gained at a much faster rate.


Because of the volatility of the stock market, it is important for index fund investors to invest monthly during any type of market. Recession? Invest. Bull Market? Invest. This is our simple plan.


If you are interested, I learned most of what I know now about index investing here: The Stock Series. I haven't looked at this blog series for years, but I am confident that it holds up.


Final Thoughts


If someone does their research and is mentally tough enough to invest in all types of markets, even during recessions, index fund investing may be a great avenue to explore.


Personally, we have most of our assets in index funds (specifically VTI and VTSAX through Vanguard).



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