5 Reasons Why You Should Invest in Index Funds
Bonus: They have a stamp of approval from Warren Buffett
Warren Buffett, the Oracle of Omaha, is one of the most successful investors of our time and has amassed his wealth from handpicking individual stocks that have outperformed the market. However, his advice for the average investor — invest in index funds. According to Buffett, “For most people, the best thing to do is to own the S&P 500 index fund” (Source: Grow).
Here are a few reasons why:
- Instantly diversify your portfolio
When you invest in an index fund, you are essentially buying small pieces of a bunch of different stocks in the fund’s portfolio, which allows you to instantly diversity your own portfolio. Thus, rather than having exposure to just 1 stock or a few stocks, you can spread your risk across multiple stocks and industries. That way, if certain stocks or industries you are bullish on are performing poorly, they will not drag down your entire portfolio. For example, for the cost of 1 Apple share, you could purchase 1 share of ARKK, which would give you exposure to Tesla, Roku, Square, Teladoc Health, Spotify, Baidu, and 50 other stocks.
2. Use low expense fees to your advantage
Compared to having a financial manager or investing in mutual funds, index funds have relatively low expense fees. Most index funds have an expense/ management fee of less than 1%, which would amount to less than $10 for every $1,000 you invest in an index fund. Some brokerages, such as Fidelity, Vanguard, or Schwab, even offer index funds with 0% expense fees. If you think of the effort and time it would take for you to actively manage your investing portfolio, the 1% fee (or less) for an index fund to do it for you is well worth paying.
3. Take the emotions out of investing
By investing in index funds and holding for the long run, you can minimize the psychological effects that investing and trading can have on you. When you invest in individual stocks, a few bad picks can really weigh you down emotionally and cause you to panic because you are making an active decision to choose which stocks to buy. I can attest to this from personal experience as I have made a few “YOLO” trades on extremely risky plays in my main portfolio that left me bag holding losses. Compared to my Roth IRA, where I park the majority of my money in index funds, my main portfolio comprises of individual stocks I am handpicking based on my own research. Because some of the stocks have higher risk, my main account requires a lot more management, leading me to check my stocks multiple times a day — sometimes at times ranging from 1AM to 6AM. In contrast, in my Roth IRA, I have faith in the index funds I choose and take a much more laidback approach.
4. Don’t need to be an expert in the stock market
Do you know how to read candlesticks? Earnings per share? P/E ratios? Financial statements? Choosing individual stocks takes a lot of due diligence, which translates to extra time and effort, as you are assessing the value of each company you choose to invest in. If you do not want to do the extra work yourself or feel overwhelmed by the thought of having to learn fundamental and/or technical analysis, index funds are a good solution for you. With index funds, you do not need to be an expert since you are essentially outsourcing the work and research that needs to be done to the experts managing the index funds.
5. It’s hard to outperform the S&P 500
According to CNBC, Barrons, and several other studies, beating the S&P 500 is not as easy as you would think. (Note: The S&P 500 is a popular stock market index that measures how the top 500 publicly traded companies in the U.S. are performing.) In CNBC reporter, Bob Pisani’s article, research indicates that the majority of active fund managers do not outperform the S&P 500 in the long run even if they have one or two good years initially. Given how difficult it to attain high growth through active investing, for the average investor, you will probably be better off passively investing in index funds.
Conclusion
While index funds may not be the perfect solution for everyone, especially those who have the knowledge and expertise to actively manage their portfolios, they are a great tool for beginners and average investors who are looking to invest but do not necessarily want to contribute the time and effort needed to invest successfully. And there you have it, 5 reasons why you should consider investing in index funds. Let me know your thoughts below!
Disclaimer: This article is for entertainment purposes only. I am not a financial advisor or financial expert. Everything I mentioned above is my personal opinion and should not be considered Financial or Legal Advice.
