3 Smart Reasons for New Investors to Choose Index Funds

3 Smart Reasons for New Investors to Choose Index Funds

When you’re in your 20’s and 30’s, planning for retirement doesn’t always end up at the top of your to-do list.

“Hmm… let’s see … check out the lineup for Lollapalooza or learn about my 401k investment options at work?”

I get it. I get it. As much as I like to nerd out on my finances, I would definitely like to grab tickets to see epic music monsters like Muse, Arcade Fire and The Killers in Chicago this summer.

BUT … What if there was a way to “set it and forget it” when it comes to your retirement planning so that you could easily go back to enjoying your summer?

You’re in luck. Meet your new friend … the Index Fund.

What is an Index Fund?

An Index Fund is an investment option that allows you to buy into an entire market index like the S&P 500. Since the S&P 500 is a running list of the top 500 US companies, owning an S&P 500-based index fund allows you to own a piece of big players like Apple, Google and Facebook. That means if you own one of these index funds, you have big money businesses working for you, the shareholder!

Although you’ll hear the S&P 500 index referenced quite often, there are other market indices as well. There are indices for bonds, international stocks and even stocks for small and growing companies.

Why Choose Index Funds?

Simple Investing

I don’t know about you, but when it comes to handling my money, I like to keep it simple. I enjoy living with no debt and having an investment strategy that helps me sleep easy at night. That is why I like Index Funds.

Whether you’re looking into options for your 401k at work or setting up a Roth IRA, Index Funds take out all of the guess-work. You’re not trying to choose the best individual stocks or choose the best performing mutual fund. Instead of trying to “beat the market”, you’re just buying into the market. And since an S&P 500 Index Fund like Vanguard’s VFINX has averaged 10.96% over the last 41 years, it’s not only a simple investment, it’s smart one too!

VFINX Performance Since 1976
Snapped from Vanguard’s website (VFINX)

Another beautiful thing about index funds is that they are inherently diversified. Using the S&P Index Fund as an example again, you are investing in the 500 best US companies across multiple industries like technology, transportation, retail and energy. You’re not pigeonholing yourself into one industry that may see a downturn in the near future.

Low Fees

When you invest in mutual funds, there is a fee called an Expense Ratio. If you’re not careful, these expense ratio fees can REALLY eat away at your earnings.

via GIPHY

Some funds can have expense ratios as high as 1% or 2%. Index Funds on average have a much lower expense ratio. Vanguard’s VFINX for example has a 0.14% expense ratio. This means for every $10,000 you invest, Vanguard gets $14 per year. Compare this to a mutual fund with a 1% expense ratio and you’ll pay $100 per year.

“$100?! That doesn’t sound like a lot”, one might say. Let’s demonstrate how the fees add up over time with a fancy schmancy chart …

Expense Ratio Fees Over Time

Let’s say you started investing with $3,000 at age 22 and contributed $5,000 annually until you were 62. If you chose the index fund with the lower expense ratio, you’re looking at a savings of $267,257.49! That $100 adds up fast, doesn’t it?!

You’ll also have $1,310,356 in your account!! Winning!

REALLY REALLY Rich People Recommend Them

Warren Buffett, one of the richest people on the planet, has stated on multiple occasions that he thinks Index Funds are where most people should be placing their money. Buffett even told his wife and the trustee to do the following with his wealth upon his death:

“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.” – Warren Buffett

Buffett even made a $1M bet that Index Funds would outperform the top hedge fund managers over a 10 year period starting. So far, Buffet is winning 66% to 22% over the actively managed hedge funds:

In short, if Index Funds work for billionaires like Warren Buffett, they work for me.

Where Do I Start?

So before you head off and have the best summer ever, take a quick look at your 401k options at work. See if there are any Index Fund options available and compare the expense ratio of the Index Funds to the other funds. You may see a big difference!

If you don’t have an IRA (Traditional or Roth) set up quite yet, look into a low-cost provider like Vanguard to set up your portfolio. Here is a simple 10 step article I wrote to get people started with their first Roth IRA.

A Fee-Only Certified Financial Planner is a great partner to have on your retirement planning journey. They will help you select the right funds and help you to rebalance your portfolio year over year. Check out XY Planning Network or the Art of Finance (I interviewed this power couple on the podcast, good people) to connect with a solid financial planner professional. Whoever you work with, make sure they are a Fee-Only CFP and a fiduciary (ethically and legally bound to act in your best interest).

The earlier you start to invest, the more wealth you’ll have. So, let’s get on it my friends!


Have you started investing for your retirement?

What do you think of index funds?


 

Author: Andy Hill

Andy Hill, a mid-30’s father of two living in the metro Detroit area, pens the MarriageKidsandMoney.com (MKM) blog taking you through the trials and tribulations of being a young parent and husband who is planning for his family’s future and winning with money.

2 thoughts on “3 Smart Reasons for New Investors to Choose Index Funds”

  1. Index funds for the win for sure. I’m more than happy to take investing advice from Warren Buffett. The best part is that it makes something that sounds so complicated (investing) really very, very simple. It’s nearly as simple as opening a bank account and putting money in it :).

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