Why You Should Invest In Index Funds

life hacking Sep 24, 2021

Let me start with a disclaimer.

I'm not a licensed financial advisor (which may be a good thing for this blog post). I'm neither a CFA (Chartered Financial Analyst) nor a CFP (Certified Financial Planner).

I'm just a Tentmaking Pastor sharing educational information that has helped me and may help you as well.

When I first started saving for retirement, the professionals that I talked to recommended that I place my money in actively managed mutual funds that would hopefully "beat the market." No guarantees of course. I didn't realize at the time how much they, and many others, would benefit from me investing in these types of mutual funds. And I also didn't realize how often I wouldn't "beat the market" by investing in these funds.

I figured if I was going to be saving hundreds of thousands of dollars over my working career investing in these mutual funds via my retirement accounts, I better understand how they work.

What I ended up learning from the likes of Warren Buffett, Jack Bogle, J.L. Collins and Burton Malkiel was that I was playing a loser's game. In other words, because the cost of actively managed mutual funds is so high, and the performance of the managers is often so low, by the time the money managers, brokers, investment bankers, etc get paid, I'm not doing very well.

That's when I learned about low-cost Index Funds which are not actively managed (this is why they are low cost).

Listen to Jack Bogle, founder of Vanguard & author of The Little Book of Common Sense Investing:

Successful investing is all about common sense. As the Oracle (Warren Buffett) has said, it is simple, but it is not easy. Simple arithmetic suggests, and history confirms, that the winning strategy is to own all of the nation's publicly held businesses at very low cost. By doing so you are guaranteed to capture almost the entire return that they generate in the form of dividends and earnings growth. The best way to implement this strategy is indeed simple: Buying a fund that holds this market portfolio, and holding it forever. Such a fund is called an index fund. The index fund is simple a basket (portfolio) that holds many, many eggs (stocks) designed to mimic the overall performance of any financial market or market sector. Classic index funds, by definition, basically represent the entire stock market basket, not just a few scattered eggs. Such funds eliminate the risk of individual stocks, the risk of market sectors, and the risk of manager selection, with only stock market risk remaining (which is quite large enough, thank you). Index funds make up for their short-term lack of excitement by their truly exciting long-term productivity.

Did you catch all that? Maybe not. Let me break it down.

If you want to consistently win with the stock market, it's not likely going to be in picking individual stocks. This is why many people avoid the stock market. They know this strategy is risky and they don't want to risk their money picking stocks they don't know anything about.

Instead, as Bogle & Buffett suggest, don't pick individual stocks, pick all of the stocks. Huh? That's what index funds allow you to do. You can, in a sense, pick the entire market. That way you make sure you own the winners (and the losers) and you end up getting the same return as the entire stock market (which is far less risky). And what's so great about this is that since you're not having to pay someone a lot of money to pick winners & losers for you (that's what actively managed mutual funds do), you don't have all of that additional cost.

Bogle says choosing index funds allows you to remove the risk of picking & choosing individual stocks, which we know is risky. It allows you to remove your risk of potentially being in low performing market sectors (like if you just held real estate stocks for example & they had a bad year). And it removes the risk of your money managers not doing very well at picking winners & losers (which they are notorious for).

Once I learned about index funds, I went into all of my retirement accounts & moved all of my money out of actively managed mutual funds & into index funds. I tried to calculate the savings of doing this over the long-term, and it was in the hundreds of thousands of dollars. Think about the difference between paying ~0.04% (index funds) and ~.5-1% (average expense ratio for actively managed mutual funds - can be even higher) of your retirement savings each year. It may not seem like a big difference, but the actively managed fund can be 10-20x higher than the index fund (or more). And you still have the risk that you actually underperform the market for the year!

Imagine you have $500,000 in your retirement accounts now:

  • At .04%, you pay $200/yr in costs
  • At 1%, you pay $5,000/yr in costs

As your accounts grow, these costs will skyrocket.

So if you, like me, want to make potentially hundreds of thousands of dollars long-term with a few clicks of your mouse, consider moving your money from actively managed mutual funds to index funds.

But, please, don't take my word for it. I want you to read about this like I did. We're talking about lots of money you're putting into retirement. It's really important that you understand where it's going.

Here are some books I'd recommend you start with (and if you only read one, pick the first one):

  1. "The Little Book of Common Sense Investing" by Jack Bogle
  1. "The Simple Path to Wealth" by J.L. Collins
  1. "The Bogleheads' Guide to Investing" by Mel Lindauer, Taylor Larimore, Michael LeBoeuf
  2. "A Random Walk Down Wall Street" by Burton Malkiel

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