Index Fund Investing Overview
July 19, 2011
Investing in index funds is a pretty basic investing strategy but we wanted to cover it for two reason:
1) There are many people who are not expert investors and need this information.
2) Regardless of how experienced you are, this is a legitimate technique, especially for people who do not have the time or resources to monitor their own portfolios.
What Are Index Funds?
Index mutual funds are funds that mirror a specific “index.” For example, an S&P 500 Index Fund consists of the 500 individual stocks and their weightings in the index itself. If you invest in the fund and check the financials, whatever happens to the index in terms of performance, happens to your fund.
Index Fund Benefits
Index funds are “passively managed.” This means that compared to other mutual funds where portfolio managers make decisions on when to buy and sell holdings, a passively managed fund can only make investment changes when the index itself changes. Index funds have very low turnover rates because the indexes do not change all that often.
This makes this type of investment more tax efficient than actively managed funds. Index funds also have much lower expenses than actively managed funds. Index funds typically have 0.1%-0.35% in management expenses compared to 1%-2.5% for actively managed funds.
Index Fund Returns
Now some of you will say the goal is not to get index-like returns. The goal is to beat them. What most people don’t realize is that roughly two-thirds of all actively managed mutual funds fail to match the investment returns of index funds.
Index Fund Examples
So how do you use this information? What kind of funds should you use for a portfolio? Here are some examples of index funds you could use in your portfolio:
Vanguard Total Stock Market Index (VTSMX) – This fund is more than just the S&P 500 index. This fund encompasses the entire US stock market. This will give an investor exposure in both mid-cap & small-cap funds as well.
Vanguard Total International Stock Index (VGTSX) – Full international exposure in one fund.
Vanguard Total Bond Market Index (VBMFX) – Tracks the Barclays US Aggregate Bond Index, gives exposure to the bond market.
Vanguard Intermediate-Term Tax Exempt (VWITX) – This fund invests in high-quality municipal bonds, and is a good option for taxable accounts.
These funds could also be used as a starting point for people who want to combine index funds with other investments. Like any other investment though, these index funds should be treated as long-term investments.
Index funds are becoming more popular finally. The advantages are just so compelling. The funny thing is that more index money will give rise to actively managed money at some point again – not anytime soon, as long as active management actually adds value. But that will be easier if there is less competitions from other active managers.