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

    5 Things You Need To Know About Index Funds

    Index funds, at their best, offer a low-cost way for investors to track popular stock and bond market indexes. But not all index funds are created equally.
  2. Investing

    The Hidden Differences Between Index Funds

    These funds don't all match index returns. Find out how to avoid costly surprises.
  3. 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. ...
  4. 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.
  5. Investing

    What You Need to Know About Mutual Funds

    Mutual funds are a good investment opportunity, but investors should know how they operate.
  6. 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.
  7. Investing

    No Load Vs. Index Fund: Is One Better Than the Other?

    Find out how no-load funds, index mutual funds and ETFs can help investors boost returns just by cutting down on expenses and sales charges.
  8. Investing

    A Guide For Picking Long Term Mutual Funds

    Learn about considerations for investors when buying shares in a mutual fund for a long-term investment, including fees, type of management and portfolio goals.
  9. Financial Advisor

    Advising FAs: Explaining Mutual Funds to a Client

    More than 80 million people, or half of the households in America, invest in mutual funds. No matter what type of investor you are, there is bound to be a mutual fund that fits your style.
  10. Investing

    Fund Management Issues

    The quality of management is a key component of a fund's success.
Frequently Asked Questions
  1. What Does it Mean if the Correlation Coefficient is Positive, Negative, or Zero?

    Learn what the correlation coefficient between two variables is and what positive, negative and zero correlation coefficients ...
  2. What's the Difference Between a Market Economy and a Command Economy?

    Set by supply and demand, a market economy operates through a price system; in a command economy, governments control the ...
  3. What Factors Cause Shifts in Aggregate Demand?

    Find out how aggregate demand is calculated in macroeconomic models. See what kinds of factors can cause the aggregate demand ...
  4. Who are Whole Foods' (WFM) main competitors?

    Learn more about Whole Foods Markets, who insists its products are sustainable. Thanks to the competition, however, its marketing ...
Trading Center