“Invest in index funds that give you exposure to the broad market of the best companies in the world and hold on to them for the long term.”

Warren Buffett

When Warren Buffett gives advice, I listen. This is the advice he gives to individual investors. Individual investors like you and me.

If you haven’t heard of Ray Dalio. Google his name and you will soon realize that he’s one of the best investors in the world. He knows what he’s talking about and when he does, I listen.

Let’s get right into it.

What’s an index fund?

An index fund is an investment fund that mirrors the performance of a market index.

Have you heard of the S&P 500 or Dow 30? These are market indexes. There are hundreds of market indexes. Not all market indexes track stocks (like the S&P 500 and Dow 30). Market indexes also track other assets like; bonds, commodities, and currencies.

You can’t buy market indexes so the next best thing is to invest in index funds because they perform as the market index does.

For example, if you want to invest in an index fund that performs like the S&P 500. You would buy an index fund that buys the 500 shares included in the S&P 500. If the mix of companies in the S&P 500 change, so does your index fund. You don’t make the change your servicer does.

Remember that an index fund mirrors the performance of a market index so if the market index is down, your index fund also goes down. For example:

Difference between index funds and eTFS

There are two types of index funds.

1.     Index Mutual Funds – an index mutual fund is what I explained above, it mirrors a market index. If the word mutual fund throws you off. Let me explain. An index fund is a type of mutual fund. A mutual fund alone doesn’t track a market index. Assets in a mutual fund are constantly changing, managers are buying and selling trying to beat the market.

2.     Index Exchange Traded Funds (ETFs) – the only difference between an index mutual fund (or just index fund) and ETF is that an ETF can be traded like a stock. It can be bought and sold multiple times a day. An index fund can only be traded once a day. If you don’t plan on trading your index fund (which for a beginner investor, I don’t recommend) go with an index fund.

benefits of index funds

1. DIVERSIFICATION

Instead of investing in just one asset (stocks, bonds, currencies, etc.), you invest in many. It’s never a good idea to put all your eggs in one basket. Or in this case, all your money in one asset.

When you invest in an index fund you are diversifying your investments and choosing to invest in multiple assets.

Unless you and I decide to become financial analysts full time. We simply are not educated enough to pick stocks individually.

You can do your best to research a stock and read the annual reports but outside factors (competitors, politics, weather, prices, etc.) are simply out of your control. The last thing you want to do is put all your money in one stock (or even 5) and lose everything.

2. LOW FEES

Instead of investing in just one asset (stocks, bonds, currencies, etc.), you invest in many. It’s never a good idea to put all your eggs in one basket. Or in this case, all your money in one asset.

When you invest in an index fund you are diversifying your investments and choosing to invest in multiple assets.

Unless you and I decide to become financial analysts full time. We simply are not educated enough to pick stocks individually.

3. better than ACTIVELY MANAGED FUNDS

In the line chart above, the red line is a traditional mutual fund. A traditional mutual fund is an actively managed fund. They have higher expense ratios because managers are doing more work.

They are constantly buying and selling assets in hopes of beating the market.

So maybe you’re thinking the expense ratio is worth it and in the end, your return (or profit) is better because it’s being managed by professionals.

Well, here are the facts. Index funds perform better than mutual funds over 90% of the time.

So maybe you’re thinking the expense ratio is worth it and in the end, your return (or profit) is better because it’s being managed by professionals.

So maybe you’re thinking the expense ratio is worth it and in the end, your return (or profit) is better because it’s being managed by professionals.

4. YOU HAVE OPTIONS

The great thing about index funds is that you have options. Lot’s of options.

If you want to invest in the entire stock market or just a sector of the stock market, you can. If you want to invest in just bonds you have the option to do that as well.

I talked about diversification as the #1 benefit of index funds. As I said, instead of buying just one stock you can buy many that are part of one index fund.

It’s also a good idea to diversify your index funds. And because you have options, it’s easy to do.

The right mix will depend on what you’re interested in or what your Registered Investment Advisor recommends. Reach out and get the best advice for your investment portfolio.

5. investor of many with one transaction

The last benefit? It’s a real time saver. I’m going to use the S&P 500 market index as an example again. Say you want to mirror the performance of the S&P 500. Do you want to make 500 separate transactions or just one? I’m guessing you answered one.

When you invest in an index fund, you make one transaction and are invested in multiple assets automatically.