Yesterday I wrote about actively investing your money, something that many people are not comfortable with. Realizing this, I decided to write about investing with Index Funds, something I’ve mentioned before but haven’t gone too in depth with. Yeah, I kind of just went a bit crazy the past few weeks and jumped into some more advanced topics on investing and saving than I probably should have. My bad! Investing with index funds is not an advanced topic though. In fact, it’s one of the greatest ways to build your wealth over time. I use it for most of my money and tend to speak my opinion about Vanguard and their amazing collection of index funds to pretty much everyone I meet.
But why, you ask? I know what you’re thinking, you want to BEAT the market, not just match it. Well here’s the thing about that: in the long run, very few mutual funds can beat the market. It’s a fact. Many of them can match or slightly under perform the market, which you might think isn’t that bad. But then you realize that the returns you’re looking at don’t take into account the fees of the manager. Typically the annual fee will be between 1.10% and 1.50% for an actively managed fund. So if you were able to match the return of the market, well, you just lost to the Vanguard S&P 500 fund, which only costs 0.17% on an annual basis, keeping your returns in your pockets. Just taking into account the costs of the index fund makes it a significantly better idea! Who wants to pay for below average returns anyway? If your 401k plan has an indexed mutual fund, take it! The lower expense ratio will save you boatloads of money down the road!
Another aspect we want to take into account is obviously the return. I mentioned above that it’s rare for a mutual fund to outperform the market and your index funds in the long run and of course, being long term focused on retirement and financial freedom, we’re all about the long run. So what has Vanguards S&P 500 fund averaged for an annual return since its creation in 1976? 10.55% a year, not including dividends paid out and reinvested. At that rate, your money will double every 7 years! Granted this rate is smoothed out but still, it’s a better return than you’ll see on any savings account or CD account. If you take $20k today and split it into two separate accounts: $10k in an ING savings account with 0.80% interest and $10k in Vanguards S&P 500 Index fund and just leave it for ten years, what do you think the difference would be? The savings account would have grown to a whopping $10,832 in those ten years. The S&P index fund, maintaining its historical growth, will be $28,587, more than double your original amount without dividends reinvested. Granted, the stock market could fall again but any student of the market knows that you can’t be too concerned with the ups and downs of the market if you’re investing passively.
By passively investing your money into index funds you can achieve good returns and you can balance your portfolio easily, without having to constantly buy and sell stocks and incur huge broker fees. Save yourself some time, set up a Roth IRA and start saving your money. The earlier you save, the better!
If you have thoughts or questions about investing or index funds, leave a comment or send me an email!