There are a lot of ways to mobilize your money, but it can be hard to sort out what investment options are the wisest choice for your specific goals and circumstances. With a wide selection of products to plan for your future, knowledge is the absolute key to optimizing your future.
Let’s face it, we’re not all going to become experts in every aspect of finance. It is important, however, to have a basic understanding of the types of investment products available. You may not be able to explain how your computer works in every detail… but you understand how the components you use work well enough that you can use your machine effectively and efficiently.
Over the next few months, we’re going to take a moment to briefly zoom in on specific types of investment products. There’s no way we can cover everything about any specific type of investment, but hopefully we can give you enough insight about how they work that you can get the most out of your portfolio.
An index fund is a type of mutual fund that is designed to track the value of a group of stocks or bonds representative of an overall market, grouped into an “index”. A market index tracks the performance of a group of individual assets, like the Dow Jones Industrial Average, the S&P 500 Composite Stock Price Index or a huge variety of other pre-made indices.
Index funds attempt to duplicate the returns of a specific index, which themselves are tracking multiple stocks or bonds. This gives investors an easy way to add a diversified asset group to their portfolio with a curated level of risk.
As index funds attempt to stay closely aligned to the returns of the index overall, these funds are typically more passively managed than other mutual funds. This is beneficial for many investors, as less trades within the fund results in less realized capital gains and the resulting tax burdens.
Index funds have risen steadily in use since Vanguard introduced the first public index in August 1976. It was the 90s, however, that really saw this investment format break out into mass popularity. In the mid 90s, passive index funds made up for less than 5% of the overall market share for mutual funds. On January 1st, 2024, that market share was over 50% for the first time ever.
So why the surge? There’s two fundamental causes why more and more investors are using passively managed index funds — Ease of access and their proven track record.
Access is huge. We now live in a world where over 60% of Americans own some kind of stock, but not everyone is some kind of investing guru. Index funds are often far more user-friendly than their managed counterparts or purchasing individual assets.
Index funds offer a passively managed asset group for a passive investor. No complex analysis is necessary to track your performance or keep up with your account manager’s strategy. Just look up the index! The strategy is always to match the returns of that index.
Even for more engaged investors, this offers a way to have a low-maintenance asset group that is diversified by nature. Without an index, you’d likely spend a substantial amount of time researching to get wide exposure to the whole market. With the abundance of different specialized index funds today, you can usually pick out exactly what you’re looking for without spending all your time shopping a la carte.
The proven performance of index funds over time cannot be overstated. Arguably the biggest reason the mid 90s saw skyrocketing interest in index funds is simply that Vanguard’s 20 year returns looked incredible. Performance history is not proof of future performance, but passive index funds have reliably shown that they will likely outperform other options over time.
As of December, 2023, 87.98% of all large-cap funds underperformed vs the S&P 500 (S&P Global, 2024) over the last 15 years. These large-cap funds are equity funds usually labeled as a safe option for a risk-averse and conservative investor… yet the longer period of time you look at since their inception, an index fund typically outperforms funds like these.
The reasons for this trend are complicated, but the absence of active management is somewhat responsible. An index fund doesn’t need constant trades within the fund to maintain the desired portfolio. This means less loads and maintenance fees for an investor. During the good times, a 3% expense ratio may be almost unnoticeable in a managed fund, but the lack of that is a huge advantage during a bear market.
There’s also a sociological component to index fund performance. An active fund manager is always going to be chasing the best returns they can get. That will often mean positioning the fund to take advantage of current momentum and cultural trends. This may set them up for great short term gains compared to the consistent index, but it also opens them up to losses from bubbles or destabilizing market shifts. An index fund does not have this bias — it simply follows the trends of every asset in the index or a representative sample. Even if a portion of the assets in the index struggle over a period, the entire index is more likely to proportionally grow overall than any individual within it.
A rising tide raises all boats. Index funds capitalize on the tide steadily rising over time throughout the market.
An Index Fund offers investors a diversified investment with a proven track record for performance over the long-term. While no investment is without risk, index funds limit that risk by creating an avenue to spread your exposure to the entire index rather than one or a few assets.
Not all index funds are equal though. Make sure you do research on any index that you’re interested in making an investment in. There’s a wide variety of index funds out there. With a little searching, you can easily find the perfect fund for you.
At Coast we’re here to help keep you on solid ground – high tide, low tide or anything in between. Monitor your entire financial portfolio all from one dashboard. Planning your future doesn’t have to be complicated – Chart your course with Coast.
The Delta
