3 Important Considerations for Investing In Index Funds.

Warren Buffett is arguably the greatest investor of all-time. He’s the CEO of Berkshire Hathaway and he made his career picking stocks that were undervalued by the market. He is the Michael Jordan of investing and is flat out brilliant. So when he speaks, I listen.

In May of 2020, during the Berkshire Hathaway virtual shareholder meeting, Mr. Buffet said something interesting.

“In my view, for most people, the best thing to do is to own the S&P 500 index fund,”
-Warren Buffett

If you’re familiar with Warren Buffett, then you’ll know he is a student of the Benjamin Graham school of value investing. In fact, Mr. Graham’s famous book, The Intelligent Investor, is what piqued my interest in learning about investing almost a decade ago. Mr. Buffett’s statement took me by surprise until I remembered he won a one million dollar bet by investing in index funds. Ultimately if index funds are good for Mr. Buffett, then they are good for me although I believe everyone should have some exposure and experience if individual equities.

Before we discuss picking an index fund, lets define what they are. According to Investopedia, “an index fund is a type of mutual fund or exchange-traded fund (ETF) with a portfolio constructed to match or track the components of a financial market index, such as the Standard & Poor’s 500 Index (S&P 500).” John C. Bogle is often credited with the invention of the index fund, however, it was actually invented by Edward Renshaw and Paul Feldstein in 1960. Nevertheless, Mr. Bogle and the investment company he created, The Vanguard Group, are largely responsible for the index fund’s mainstream adoption.

Because an index fund aims to own all of the stocks of a particular index (benchmark), there is very little “stock picking” required. Active management, aka “stock picking” has been shown over time to have inferior returns to the passive strategy of index fund investing. Index fund investing, is similar to copying the smartest kid, in the hardest class in school, to ensure you get the best grade. These investments are designed to require little effort by the investor while having low fees and providing portfolio diversification. All in all, they are great investments for those who like the slow and steady route for growing their wealth.

So, how do you know which one to invest in? Well there are three main factors to consider before making an investment decision.

1. Pick an Established Index

There are currently 1,732 index portfolio options to invest in and its only growing with each passing day. The most popular and probably well known index is the S&P 500, but there are a number of other options. Some common indexes include:

Index	Market Composition
S & P 500	500 of the largest companies listed on stock exchanges
Russell 2000	Small-Cap Stocks
Wilshire 5000	Total Stock Market Index
Bloomberg Barclays US Aggregate Bond Index	Total Bond Market index
Dow Jones Industrial Average	30 Large-Cap Stocks listed on stock exchanges
NASDAQ Composite Index	Over 3000, stocks listed on the NASDAQ exchange

Given the number of index options available the odds are you typically will find an index that tracks most of the stuff you’re interested in. However if you’re getting started in investing, its probably smart to start with an ETF or MF that constructed to track a well known benchmark like the S&P 500 or just the entire stock market.

2. Fund fees should be low.

The major benefit to index fund investing is avoiding the associated fees from transactions (although this is becoming a thing of the past) and the tendency to try to time the market when investing. Index funds should be largely passive, however there are active funds that exist as well. Lower fees, demonstrated by the expense ratio as well as any transactional and/or management fees typically correlate with the degree of activity needed to manage the fund to stay correlated with its chosen benchmark.

Fees are paid no matter how well the fund performs, thus your goal should be to pick a fund with an amazing track record, performance, and low fees.

3. The older the fund, the more likely the stability of the fund.

The goal in investing is more of not losing as opposed to constant winning. To adhere to this goal, we make calculated bets based upon the riskiness of the investment. As stated above, the amount of index fund options are extensive, so there is relative safety in choosing a company (fund provider) that is older and well established. I’ve mentioned Vanguard a few times in this post, because quite honestly I believe they are the best option for new investors. However there are other options such as Fidelity, who offers a zero expense ratio index mutual funds that have no investment minimum, or State Street which since 1993 has offered the SPDR S&P 500 ETF (Stock Ticker: SPY) , which was the first U.S. listed ETF.

Overall, it’s hard to make a bad choice with index fund investing, but not impossible. So please keep the above considerations in mind when making a decision.

As always if you have questions or concerns regarding creating an emergency fund, investing, real estate, insurance, or planning for the future, don’t be afraid to speak with qualified financial advisor. Smart Asset has a great tool to find an advisor in your area or feel free to email me (contact@surgifi.com) to help you on your path to financial independence.