1. Index Investing: Introduction
  2. Index Investing: What Is An Index?
  3. Index Investing: The Dow Jones Industrial Average
  4. Index Investing: The Standard & Poor's 500 Index
  5. Index Investing: The Nasdaq Composite Index
  6. Index Investing: The Wilshire 5000 Total Market Index
  7. Index Investing: The Russell 2000 Index
  8. Index Investing: Other Indexes
  9. Index Investing: Index Funds
  10. Index Investing: Conclusion


Indexes are great tools for telling us what direction the market is taking and what trends are prevailing. So, how do we buy into these investment vehicles? Imagine the costs associated with buying the 6,500+ stocks that make up the Wilshire Total Market Index. Commission fees alone would run into the tens of thousands!

If you've been paying attention throughout this tutorial, you've probably noticed we mention index funds more than once. Index funds are simply mutual funds that based on an index and mirror its performance.

The thinking behind index funds has some academic substance to it. For years, many academics have been saying that it is impossible to consistently beat the market without raising your risk level - a theory known as Efficient Market Hypothesis (EMH). So in 1975, John Bogle took the stance that "if you can't beat 'em, join 'em" and created the first low-cost mutual fund that mirrored the S&P 500 index.

But, wait a minute. Isn't the whole purpose of mutual funds to coax us lowly investors into enlisting the help of professionals who can achieve superior returns? That's the idea the mutual fund industry has been trying to sell us for many years. The truth is that a majority of mutual funds fail to outperform the S&P 500. The exact stats vary depending on the year, but on average, anywhere from 50%-80% of funds get beat by the market. The main reason for this is the costs that mutual funds charge. A fund's return is the total return of the portfolio minus the fees an investor pays for management and fund expenses. If a fund charges 2%, then you have to outperform the market by that amount just to be even.

Here's where index funds enter the picture. Their main advantage is lower management fees than you would get from a regular mutual fund. An average non-index fund has an expense ratio of around 1.5%, whereas many index funds have an expense ratio of around 0.2%!

The reason the costs are lower is because an index fund is not actively managed. Fund managers only need to maintain the appropriate weightings to match the index performance - a technique known as passive management. The deceptive thing about the "passive" label is that most indexes are actively selected. Take the S&P 500, for example: when the index changes, it's almost like getting the S&P Index Committee's advice for free.

Investing in an index fund doesn't guarantee that you'll never lose money. You will go down in a bear market and up in a bull market. Historically, the return of the S&P 500 has been around 10-11%, which is pretty good. The key here is to hold on for the long term. If you get nervous during a downturn and sell, you'll probably miss the recovery.

Index Investing: Conclusion

Related Articles
  1. Investing

    The Lowdown On Index Funds

    If you can't beat the market, why not join it? Read on to go over your options.
  2. Financial Advisor

    The 4 Best U.S. Equity Index Mutual Funds

    Find out which four index mutual funds are among the best U.S. equities index mutual funds for core holdings in your investment portfolio.
  3. Investing

    The Hidden Differences Between Index Funds

    These funds don't all match index returns. Find out how to avoid costly surprises.
  4. Investing

    What are Index Funds?

    An index fund is a type of mutual fund that is tied to a broad stock index like the S&P 500 or the Dow Jones Industrial Average, instead of being handpicked and managed by an investment manager. ...
  5. Investing

    3 Index Funds with the Lowest Expense Ratios

    Read detailed information about index mutual funds with some of the lowest expense ratios in their categories, and learn about their pros and cons.
  6. Investing

    Enhanced Index Funds: Can They Deliver Low-Risk Returns?

    These funds may look appealing. Find out whether they can really live up to all of their promises.
  7. Investing

    4 Expensive Mutual Fund Mistakes to Avoid

    Mutual funds are a good way to balance your asset allocation but there some potentially expensive pitfalls investors need to be aware of.
  8. Investing

    Make Sure You Avoid Adding These Mutual Funds to Your 401(k)

    Find out which five types of mutual funds you should avoid in your 401(k), including why buying this year's hottest fund is likely a losing bet.
  9. Investing

    Fund Management Issues

    The quality of management is a key component of a fund's success.
  10. Investing

    Trading Mutual Funds For Beginners

    Learn about the basics of trading and investing in mutual funds. Understand how the fees charged by mutual funds can impact the performance of an investment.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center