Become a millionaire investing in Index funds.
You may have heard of index funds or this is totally new to you, whatever the case, let’s break it down
When trillions of dollars are managed by Wall Street charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds
Warren Buffett the most successful investor of our time wrote the quote above in a 2016 letter to shareholders
He has also recommended index funds in other interviews but we will not just take his advice, instead let’s look at index funds
An index fund is like a football league, at the end of every season clubs that meet the criteria remains in the league while those that don’t are demoted and others promoted
Think of the football clubs as companies and the league as an index fund
An index is only a mathematical construct that tracks the movement of various sectors, markets, strategies, etc
The most popular index is the Standard & Poor’s index (S&P 500) which is an index tracking the top 500 companies in the US
Over time, as companies are added and removed from the index, the fund manager replicates those changes in the fund.
It’s easy to get started irrespective of the platform you choose. Let’s walk through the steps to take when investing in index funds.
To win with index funds you need time in the market. Think long term
There are hundreds of different indexes you can track using index funds.
Some track large US companies, like the S&P 500, others track international stocks or emerging markets but a broad-based index is a good place to start
A few examples of broad-based indexes include
Other index categories
Once you’ve chosen an index, you can find at least one index fund that tracks it.
If you have more than one index fund option, you’ll want to consider a few things such as
To buy you need to open an account with a provider, again consider the costs and features and also take advantage of tax-advantaged accounts in your area
It’s so simple that almost every beginner investor can start today, with many investment platforms providing these funds.
You can access and invest in an entire market through one fund.
Instead of having a fund manager actively trading and/or a research team analyzing companies, you just set up your account with either a direct debit or lump sum and the fund does the rest.
The absence of fund managers and analysts reduces your costs.
Imagine buying an index fund that tracks the S&P 500, with one purchase, you get to own a piece of over 500 companies becoming instantly diversified.
Index funds often hold hundreds or even thousands of shares or bonds, you reduce risk by spreading your investments like this.
“Don't look for the needle in the haystack. Just buy the haystack”
For me, this is where index funds really shine. Index funds are cheap to run because they’re automated to mimic the index they follow.
The major cost to consider
Expense Ratio. These are costs associated with running the fund.
This operating cost is low for index funds because of its passive and simple nature
Unlike actively managed funds with high fees, because they need to pay salaries and commissions
Imagine paying 1 – 2% to fund managers against 0.05% – 0.3% paid when investing in index funds
Other costs associated with actively managed funds are sales commission, trading costs, tax-cost ratios
Because you are mimicking an index, investors will get the same returns as the index minus fees which we have established is very low.
Individual companies both outperform and underperform the market, but, in general, the overall stock market increases in value over time.
The average return for the S&P 500 for the last 10 years is 13%, within that time there have been highs and lows.
Many actively managed accounts can’t boast of this return and even if they do when you factor in fees they definitely fall short.
Many index funds simply hold what’s in the index so investors know the fund’s holdings. This transparency lets you better judge an index fund’s risk based on those holdings.
This advantage is commonly overlooked
Actively managed funds in taxable accounts have to pay tax on gains when they sell and this could be a huge hit because of high activity
In comparison index funds investors pay very little because they buy and hold with little or no activity
Take advantage of tax-advantaged accounts in your country. – ISA (UK), Roth IRA (USA), TFSA (Canada), SUPER (Australia)
Index funds are excellent investments, sometimes there will be dips in the market but over a long period, it has shown to gain value and grow.
