30 Day Investing Challenge, Day 15: Know What An Index Fund Is
Picture this: Diana Ross plays on the radio, Jimmy Carter wins the presidency, The Lutz family flees their Amityville home in terror, the Steelers defeat the Cowboys, and the Cold War is in full swing. Tell me it’s 1976 without telling me it’s 1976. A lot happened in this year, but one notable event that is often overlooked is the invention of the first index fund by Vanguard Group (yes, that Vanguard) founder Jack (John) Bogle.
Because of a serious snafu in his investing career, Bogle was no longer allowed to actively manage other people’s money. So he created a fund that tracked the Standard & Poor’s index of 500 companies (S&P 500) instead. Thus the index fund was born. Thanks to this and the invention of the internet (thank you Al Gore… Just kidding) we now have a way of rapidly and easily growing our wealth that generations before us didn’t. We should consider ourselves incredibly lucky to be living in times where a couple of clicks on our computer could set us up for life.
What Actually Are Index Funds?
What is an index fund anyway? Index funds are passive investments that track an index by mimicking their makeup. An index is a group of financial instruments that represent and measure the performance of a specific market, asset class, sector, or investment strategy. Before index funds, investors had to entrust their money to stock brokers, who actively traded in and out of stocks causing high costs for their clients. But because index funds simply track a group of assets, they take the guesswork and expense out of investing.
Why Index Funds?
Here are 5 reasons to choose index funds as the bulk of your portfolio:
Affordability: Index funds have lower fees because they are passively managed.
Market representation: Because index funds track a large part of the market, they’re inherently diverse without you having to do any work.
Transparency: Since they mimic a market index, the investments in an index fund are straight forward.
Historical performance: Over the long term, most index funds outperform actively managed funds, especially after accounting for fees and expenses. For example, from 2018 to 2023 87% of actively managed funds underperformed the S&P 500. Over a 15 year period that number jumps to 92%.
Tax efficiency: Less activity in passive index funds means there are fewer taxable events, making them more tax-efficient than actively traded funds.
The best index funds are those that track a broad piece of the market because you have a much more diverse set of investments within one portfolio. So if a company goes bankrupt and drops out of the index, you have nothing to worry about because of the hundreds of other investments in the fund. The two most popular indexes are the S&P 500 and total stock market. If you own an index fund that tracks one of these you would own 80%+ of the entire stock market (note: there are no bonds in these types of funds, only stocks).
Action Step: Compare the Top 3 S&P 500 Index Funds
Since the S&P 500 is the most popular index, let’s look at 3 index funds that track it:
Create a chart that has 5 columns and 4 rows; the column headers should be: Fund, Inception Date, Expense Ratio, Min Investment, and 10 Year Performance
Look up ticker symbols VFIAX, FXAIX, and SWPPX — put these under the “Fund” column
Record each fund’s inception date, expense ratio, minimum investment amount, and 10 year performance returns (in a percentage)
Without knowing anything else, which of these funds would you choose and why? Write your explanation down.
Your chart should look something like this.
I’ll see you here tomorrow for your next challenge: Know what an ETF is.
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