Index Fund Investing
Own the whole market for pennies: why index funds beat most pros, the common funds to know, and the simple three-fund portfolio.
TL;DR
- An
indexFundbuys the whole market at once, so you own thousands of companies for one low fee. - Over long stretches, most active funds trail their index, and the ones that win are hard to pick in advance.
- A simple
threeFundmix of US stocks, international stocks, and bonds covers almost everything you need.
Why Index Funds Work
Own the Whole MarketOne fund holds every major company, so no single one can hurt you.
Buy the haystack, not the needleMost Pros Lose to ItOver 15 years, roughly 9 in 10 active funds trail their index.
~90% of active funds lag over 15 yrsTiny FeesPassive funds cost a fraction of what active funds charge.
0.03% index vs 1.00%+ activeNothing to ManageNo stock picking and no market timing required.
Set the deposit, leave it aloneCommon Index Funds
Total US MarketHolds essentially every US public company in one fund.
VTI / FSKAX / SWTSXS&P 500The 500 largest US firms, about 80% of the market's value.
VOO / FXAIXTotal InternationalCompanies outside the US, developed and emerging.
VXUS covers the rest of the worldTotal Bond MarketThousands of bonds in one fund for stability.
BND for the bond sideThe Three-Fund Portfolio
US StocksYour main growth engine over the long haul.
e.g. 60% total US marketInternational StocksSpreads your bet beyond a single country.
e.g. 20% total internationalBondsA cushion in downturns and fuel for rebalancing.
e.g. 20% total bond marketAdjust to YouTilt toward more bonds as your goal gets closer.
Nearer the goal? Hold more bondsIndex Investing Rules
Automate and HoldBuy on schedule and stay the course through every headline.
$400/mo, ignore the newsRebalance YearlyReset back to your target mix about once a year.
Trim what grew, top up what laggedMind Fund LocationKeep bonds in tax-sheltered accounts where you can.
Bonds in the IRA, stocks anywhereSkip Niche FundsAvoid pricey themed or single-sector trackers.
Broad and cheap beats trendyTips
- Choose broad
indexFundsover active funds; across 15 years more than 90% of active managers fail to beat their benchmark after fees. - Automate a fixed monthly buy no matter the headlines; steady contributions into low-cost
indexFundsbeat trying to time the market.
Warnings
- Skip pricey themed or single-sector index funds; their higher
expenseRatiosand narrow bets undo the whole point of broad indexing. - Do not sell your index shares during a market drop; broad indexes have always recovered and gone on to new
allTimeHighs, but only for those who stayed in.
In Practice
Compare the same savings in a 0.03% index fund versus a 1.00% active fund.
You invest $500/month for 30 years ($180,000 in) and both funds return 8% before fees.
- Index fund: 8% - 0.03% fee = 7.97% net, growing to about $743,000.
- Active fund: 8% - 1.00% fee = 7.00% net, growing to about $609,000.
- The gap: $743,000 - $609,000 = about $134,000.
- That $134,000 went to fund fees, not to you, for the same market return.
You keep about $134,000 more just by choosing the low-cost index fund.
In investing you get what you do not pay for; low fees are one of the few guaranteed edges.
FAQ
An index fund is a fund built to copy a market benchmark, like the S&P 500 or the total US market. Instead of paying a manager to pick winners, it simply holds everything in the index, which keeps costs tiny and spreads your risk across many companies.
As a group, all investors together earn the market's return before costs, so the average active fund must trail the index by roughly its fees. High costs and constant trading are a headwind that compounds, which is why most active funds fall behind over 10 to 15 years.
It is a simple, complete portfolio made of just three index funds: a total US stock fund, a total international stock fund, and a total bond fund. You set the percentages, automate contributions, and rebalance once a year. It is cheap, diversified, and easy to run.
No, you already own them. Because an index holds the whole market, every future star company is in there. A handful of big winners drive most of the market's long-term gains, and indexing guarantees you hold them instead of hoping to guess which ones they will be.