Index Fund Investing
Index funds are the most important innovation in investing history. They're simple, cheap, and beat most professional investors. Here's everything you need to know.
What Is an Index Fund?
An index fund is a collection of stocks (or bonds) designed to match a market index. Instead of a manager picking stocks, the fund simply owns everything in the index.
An S&P 500 index fund owns all 500 stocks in the S&P 500, weighted by market cap. When Apple makes up 7% of the index, it's 7% of your fund.
Why Index Funds Beat Stock Picking
Most Active Managers Underperform
Over 15 years, about 90% of actively managed funds underperform their benchmark index. Professional stock pickers, on average, destroy value after fees.
Low Costs
Index funds charge 0.03-0.20% annually. Active funds charge 0.50-1.50%. That difference compounds dramatically over decades.
Diversification
One fund = hundreds or thousands of stocks. No single company can sink your portfolio.
Simplicity
No research required. No timing decisions. Buy regularly, hold forever.
Popular Index Funds
| Fund/ETF | Tracks | Holdings | Expense |
|---|---|---|---|
| VTI / VTSAX | Total US Stock Market | ~4,000 | 0.03% |
| VOO / VFIAX | S&P 500 | 500 | 0.03% |
| VXUS / VTIAX | Total International | ~8,000 | 0.07% |
| VT | Total World | ~9,800 | 0.07% |
| BND / VBTLX | Total US Bond | ~10,000 | 0.03% |
The Three-Fund Portfolio
Many investors build entire portfolios with just three funds:
- VTI — US stocks
- VXUS — International stocks
- BND — US bonds
Adjust percentages based on age and risk tolerance. A young investor might be 80% stocks (60% US, 20% international), 20% bonds.
VTI vs VOO
VTI (Total Stock Market): Owns ~4,000 US stocks including small-caps
VOO (S&P 500): Owns 500 largest US stocks
They perform almost identically because large-caps dominate both. Either works. Some prefer VTI's slightly broader diversification.
ETF vs Mutual Fund
VTI (ETF) and VTSAX (mutual fund) track the same index. Key differences:
- ETFs trade intraday; mutual funds once daily
- ETFs have no minimums; VTSAX requires $3,000
- Mutual funds are easier for auto-investing
- Returns are virtually identical
How to Start
- Open a brokerage account (Fidelity, Schwab, Vanguard all excellent)
- Decide on allocation (e.g., 80% VTI, 20% VXUS)
- Buy index funds
- Set up automatic investments if possible
- Rebalance annually
- Ignore market noise
Common Mistakes
Panic Selling
Markets drop 30%+ periodically. Those who sell lock in losses. Those who hold (and keep buying) come out ahead.
Performance Chasing
Last year's hot fund is often this year's dud. Stick with broad indexes.
Overcomplicating
You don't need 20 funds. VTI alone provides exposure to ~4,000 stocks.
The Bottom Line
Index funds are the closest thing to a "free lunch" in investing. Low costs, broad diversification, and market returns beat most alternatives over time.
The formula is simple: buy total market index funds, keep costs low, stay invested, and let time work for you.
Start Index Investing Today
All major brokers offer commission-free index funds.
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