Are Index Funds Really As Great As Everyone Thinks?
By Preston Rosamond
In the fall of 2019, index funds finally surpassed actively managed mutual funds. As of August 31 of last year, $4.27 trillion was invested in index funds and only $4.25 trillion in their active counterparts. (1) Clearly, index funds have seen an incredible rise in popularity over the last decade. The question, though, is whether or not their popularity is justified. Are index funds really as great as everyone thinks? Here are some benefits they could add to your portfolio.
Increased Diversification
One of the valuable perks of index funds is the diversification that they offer. Diversification is important because it helps to mitigate risk. When investing in a fund that tracks the S&P 500 Index, for example, your money is invested in around 500 companies across a variety of sectors. Such diversification provides a cushion against the failure of any one company or even a specific industry.
Many investors like index funds because with the purchase of only one fund, they immediately have a diversified portfolio. It makes diversification very simple to achieve.
Easy To Understand
Index funds are simple in other ways as well. It is easy to understand what you are investing in when it tracks an index, especially one of the major ones. It’s clear which part of the market you are tracking, which aids in decision-making. With the complexity of some of the investment vehicles available today, many investors appreciate the simplicity and clarity of investing in index funds.
A History Of Market Returns
Another favorable aspect of the simplicity of index funds is that they do not try to beat the market. While that may sound like a bad thing, it actually makes for much lower stress and a more secure investment experience. Between 2001 and 2016, more than 90% of active fund managers underperformed their benchmark. (2) That means that while some actively managed funds had higher returns than their comparable index, most did not.
What’s wrong with market returns anyway? The S&P 500 Index has averaged around 10% a year for nearly a century. (3) That’s a pretty good return. There is no guarantee that it will continue to produce the same returns, but it shows that market returns are nothing to frown upon. Why try to beat the market if the majority of people who do fail?
Low Cost
Perhaps the greatest advantage of investing in index funds is their cost. With an index fund, there is no one researching companies and trying to figure out which stocks to buy. There are no fund manager salaries to pay. Because of this, index fund fees are usually significantly lower than those of actively managed mutual funds.
Fund fees can have a big effect on returns over the long run. Even if an actively managed fund is able to beat the market, they have to do so by a wide enough margin to more than cover their higher fees. As such, even some funds that beat the market end up with lower returns once fees are taken into account.
Yes, Index Funds Are Great
By now you should have an idea of how we would answer our original question. At The Rosamond Financial Group, we believe that index funds really are as great as everyone thinks. They are an excellent, simple way for investors to achieve diversification and market returns for a low cost.
In light of this information, do you feel the need to take a second look at your portfolio? Are your investments generating sufficient returns to justify their fees? We can help. Book a free introductory meeting online!
About Preston
Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with nearly two decades of industry experience. He provides comprehensive wealth management and financial services to individuals, professionals, and families who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch and a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing smrosamond@rosamondfinancialgroup.com or schedule a call with our online calendar.
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(1) https://www.wsj.com/articles/index-funds-are-the-new-kings-of-wall-street-11568799004
(2) https://us.spindices.com/documents/spiva/spiva-us-year-end-2016.pdf
(3) https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp