Warren Buffet, who is arguably one of the most successful investors of all time, is a big fan of investing in index funds. In fact, he has instructed the trustee of his estate to invest 90% of his portfolio into index funds after he dies.
“I just think that the best thing to do is buy 90% in S&P 500 index fund.” – Warren Buffet
Those are some pretty powerful words from a pretty powerful man.
But what the heck is an index fund you ask?
What is an Index Fund?
As Vanguard defines it:
“An index mutual fund tracks the performance of a specific market benchmark—or “index,” like the popular S&P 500 Index—as closely as possible. Instead of hand-selecting which stocks or bonds the fund will hold, the fund’s manager buys all (or a representative sample) of the stocks or bonds in the index it tracks.”
Essentially, when you invest in an index fund, you have a large bucket that is filled with small pieces of all the major companies in a particular market.
Let’s use an example to see what this actually looks like.
Let’s say you want to invest in Vanguard’s S&P 500 (VFIAX) fund. This fund gives you a small piece of the 500 largest US companies, which covers a lot of different industries (i.e., technology, financial services, healthcare, communications, consumer goods etc.)
That means you will own shares in companies like Apple, Microsoft, Facebook, Tesla, JP Morgan Chase, etc. without having to individually pick these stocks or do any research of your own.
Why Index Funds Are So Powerful
If you take a look at the history of the stock market, the average 10 year returns has been 9.2%, according to Goldman Sachs. The S&P 500 has done even better than that, with 13.6% annual returns.
If you look back all the way to 1965, data has shown the compounded annual gain in the S&P 500 between 1965-2020 was 10.2% (Berkshire Hathaway).
Those are some awesome overall returns.
However, the market performs differently each year, and some of those years showed significant declines, followed by significant increases.
That’s why it’s important that the money you invest into the stock market, be money that won’t be needed in the short-term. You should allow your money to be in the stock market for at least 10 years, but the longer you leave it, the better.
Another amazing benefit to using index funds are the extremely low fees. Because the manager of the fund isn’t hand selecting stocks, they can keep the fees to a bare minimum. The funds that I outline below all have extremely low fees between 0.02% with the highest fee being 0.11% (which is still insanely low).
For example, a 0.04% fee on a $10,000 investment would only cost you $95 over 10 years!
Great Funds to Choose From
The funds that you choose depend on the brokerage that you purchase them through. Some of the brokerages that I personally like are Vanguard, Fidelity and Charles Schwab.
Of course, there are a ton of other brokerages out there so I would encourage you to do your own research, but these are a few of the major ones and ones that I personally use.
This is by no means an exhaustive list of the funds available, just some of the ones I have researched and that have great returns and very low fees.
Vanguard Funds
Vanguard Total Stock Market Index Fund (my personal favorite!)
Ticker: VTIAX
A total stock market fund means you own a small piece of over 3,500 companies (including small, medium and large companies).
Average annual returns (over a 10 year period): 15.15%
Vanguard 500 Index Fund
Ticker: VFIAX
Enables you to own a small piece of 500 of the largest companies in the US (as described above).
Average annual returns (over a 10 year period): 15.31%
Vanguard Total International Stock Index Fund
Ticker: VTIAX
A fund that invests in non-US stocks (providing exposure to developed and emerging international economies).
Average annual returns (over a 10 year period): 5.74%
Fidelity Funds
Fidelity Zero Total Market Index Fund
Ticker: FZROX
The fund seeks to provide investment results that correspond to the total return of a broad range of U.S. stocks.
Average annual returns (since inception in 2018): 17.92%
Fidelity 500 Index Fund
Ticker: FXAIX
Seeks to provide investment results that correspond to the total return performance of common stocks publicly traded in the US.
Average annual returns (over a 10 year period): 15.34%
Fidelity Zero International Index Fund
Ticker: FZILX
The fund seeks to provide investment results that correspond to the total return of foreign developed and emerging stock markets.
Average annual returns (since inception in 2018): 8.72%
Charles Schwab
Schwab Total Stock Market Index Fund
Ticker: SWTSX
The investment seeks to track the total return of the entire U.S. stock market, as measured by the Dow Jones U.S. Total Stock Market Index.
Average annual returns (over a 10 year period): 16.13%
Schwab S&P 500 Index Fund
Ticker: SWPPX
Simple access to 500 leading U.S. companies and captures approximately 80% coverage of available U.S. market capitalization
Average annual returns (over a 10 year period): 15.27%
Schwab International Index Fund
Ticker: SWISX
Invests in the largest companies across 21 developed markets in Europe, Australasia and the Far East
Average annual returns (over a 10 year period): 6.23%
How to Invest in Them
A lot of these funds require a minimum investment of $3,000.
What if you don’t have that amount to invest?
Not to worry.
All of these funds can be purchased as an Exchange-Traded Fund (ETF). Which means that if you prefer lower investment minimums you can buy an ETF for the price of 1 share.
Here is a great breakdown to compare the differences between an ETF and a mutual fund if you want to learn more.
You can simply go to any of the brokerage websites I compiled above and get started in a matter of minutes. It is truly the easiest and most low-key way to get started with investing.
A Real Life Example
2020 was the year we started getting a lot more serious with investing. In 2020, we were able to invest about $33k into our 401k and Roth IRAs which are invested in low cost index funds through Vanguard. Here’s the breakdown below:
401k: contributed $20,926 (includes employer contribution)
2020 annual return on 401k: $19.14%
Roth IRAs: contributed $12,000 ($6k for each account)
2020 annual return on Roth IRAs: 31%
Total gains in 2020: $21,160
So we contributed $33k into these boring but highly effective index funds and they made us a little over $21k. Pretty amazing right?!
You guys, this is why I love this stuff. We used to just put money into a savings account, sitting there making less than 1% each year. Now for no extra effort, we pour that same money into a low cost index fund and our money grows year over year like clockwork.
In Conclusion
if you are like most people, you don’t have the time or desire to study the market, hand-select stocks or spend hours a day managing your finances.
Most people want an option that allows them to invest their money, spend almost no time at all on managing their accounts, simply set it and forget it and watch their money grow.
That is truly why I love index funds. You can get consistent returns of 10% over the long term with extremely low fees.
There you have it. It’s not the most riveting stuff in the world, but it’s an incredible way to build wealth.
I’d love to hear from you on this topic. What questions do you have? Do you use this method for investing or do you prefer a more hand-on approach?
