3744: Why I Invest with Index Funds by ESI of ESI Money on Passive Investing

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[00:00:53] This is Optimal Finance Daily. Why I invest with index funds by ESI of ESIMoney.com. And I'm Justin Malek. Welcome back to the podcast where I read an article to you every day of the year with permission from the authors. So let's get right to it as we optimize your life.

[00:01:19] Why I invest with index funds by ESI of ESIMoney.com. I've mentioned a few times that I have a good portion of my assets in index funds of various kinds, including US stocks, international stocks, and so on. Today I would like to give the reasons I have used index funds as my primary investment vehicle for the past 15 years or so. Before I begin, I'd like to make a book recommendation.

[00:01:47] If you want a great and detailed read on why index fund investing is a winner, pick up a copy of The Boglehead's Guide to Investing. It will give you all the specifics you would ever want on the benefits of index fund investing. But if you're more of an I'll-take-the-summary person, this post is perfect for you. I'll just hit the highlights. Here are the reasons I like and use index funds.

[00:02:13] Number one, they deliver better returns than most actively managed funds because of the combination of good returns and low costs. By definition, index funds deliver the same results as a standard market index, such as the S&P 500, on a gross basis. These are generally good returns for investors. Not the greatest or best, mind you, but they are generally solid.

[00:02:43] But what really turns the tide for index funds is that investors don't keep the gross returns of their investments. They keep the net returns. You see, every investment has costs associated with it. And this is where index funds shine. They have very small expense ratios. This means that owners of index funds earn, or keep, most of the money their fund earns. Index funds tend to be less expensive.

[00:03:13] Much less expensive, in fact, than most other investment options. And certainly much less than average when compared to actively managed mutual funds. Their fees, trading costs, taxes, and on and on are usually the lowest you can find. As such, on a net return basis, the money you actually end up with, index funds tend to perform better than average in any given year.

[00:03:39] On the other hand, actively managed funds have average fees of 1% to 2% or so, but can go much higher depending on the fund. This eats into an investor's return, and over a few decades is a killer to overall return. Consider which option is better. An index fund returns 10% gross in a year and costs the investor 0.05% in expenses.

[00:04:08] The investor's net return is 9.95%. And an actively managed fund returns 10.5% gross in a year, far surpassing the index fund's results, but costs the investor 1.1%. The investor's net return is 9.4%. This is an example where an actively managed fund beats the index, and yet the net returns are lower than an index fund.

[00:04:38] Add in the fact that research shows that there's no proof that actively managed funds beat index funds on even a gross basis. So an actively managed fund might deliver 9.5% gross return, and then have to deduct 1.1% for costs. Ugh. Number two, they take a minimum amount of time and effort to manage. Let's face it. Time is money. Money.

[00:05:07] You have a limited amount of money. You have a limited amount of it, and whatever you spend it on costs you something. Money managers spend 60 to 70 hours a week and millions of dollars to get an extra 0.1% investment return. Do you have this much time to spend to barely eke out a small gain? Would it be worth it even if you could do so? On the other hand, index fund investing is easy. Here's what I've done for years.

[00:05:35] My paycheck is deposited automatically into my checking account. From there, it is sent automatically to Vanguard, where it buys fund shares based on my asset allocation, how much I wanted to set aside in each type of index fund. I review the results once a quarter or so, and once a year, I rebalance the assets to be sure they reflect the mix I want. And other than that, I ignore my investments. Easy peasy.

[00:06:04] Very little time and effort required. Number three, they make diversification easy. Index funds help you diversify, which gives you a better overall return over time, in two ways. First, they're generally diversified within themselves. For instance, a U.S. stock index fund may own hundreds of stocks, so if one tanks, it won't kill your return.

[00:06:31] And it will likely be offset by another one doing very well. And second, if you pick a few index funds, they will work together to diversify your total holdings. For instance, you may want index funds in these categories to diversify. U.S. stocks. Bonds. International stocks and bonds. Real estate. And so forth. Again, easy peasy. And number four, you can't beat them.

[00:07:00] Many people will argue that they can beat index fund returns after expenses over a long period of time. While it's not impossible to do this, it's highly improbable. As I mentioned, money managers and investment companies invest tons of time and money to beat indexes, and yet, most of them can't. So if they can't with all their time and resources, what makes you think you can?

[00:07:25] People will say that those are large institutions and they can't be as nimble as individual investors, and that's why their return is lower. Yes, they are big and they aren't nimble. But I don't think this gives an individual investor a lot of advantage, especially when he lacks the time, money, and knowledge larger investors do. Let's face facts.

[00:07:48] It requires a very unique individual, one who has just the right temperament, abilities, and amount of time to beat index funds. This means that all but the Warren Buffetts of the world can't beat index funds. For the sake of putting a number to it, let's say 1% can do better than an index. So do you think you are in the 1%? Odds are that you are not.

[00:08:14] And even if you are, do you think it's worth the time and effort you have to expend to do so? Probably not. Index funds are not perfect. Does this mean that index funds are the best investment for everyone in every situation? No, of course not. There are too many different factors, goals, personalities, and so on to say that almost anything in personal finance is for every person in every situation.

[00:08:44] But is an index fund investment strategy the best option for most people? I believe it is. All of this said, we're really discussing an issue that's not the most vital to investment performance, return rate. Sure, it's important enough, but when it comes down to it, time and the amount invested are much more important to growing your wealth over time than return rate.

[00:09:10] That's why I try to get a good return, which index funds can certainly deliver, but mostly focus on saving and investing as much as I can, as soon as I can. I don't need to take the added risk to try and get a great return. I can control these latter factors much more than I can return rate, and since they are more important, this is where I focus my efforts. Over time, doing this will yield tremendous results.

[00:09:42] You just listened to the post titled, Why I Invest with Index Funds by ESI of ESIMoney.com. I'll be right back with my commentary. This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome? That's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks. Gemini and Chrome is here for it.

[00:10:11] Ready to make anything online make sense? There's no place like Chrome. Check responses set up required. Compatibility and availability varies 18+. If I ran a home service business, I'd probably be an electrician. But doing great work is only one part of the job. I could be up in an attic while calls, texts, estimates, and new leads keep coming in. That's where House Call Pro comes in. It brings scheduling, dispatching, invoices, payments,

[00:10:39] and customer follow-up together in one place so fewer things fall through the cracks. On average, pros using House Call Pro save more than eight hours per week. And on average, pros grow the monthly revenue they generate through House Call Pro by more than 35% in their first year. House Call Pro is already trusted by over 200,000 pros. Ready to save time and win more jobs? For a limited time only,

[00:11:05] our listeners get 50% off base plans for their first three months when you head to housecallpro.com slash OFD. That's housecallpro.com slash OFD for 50% off. After you sign up, they'll ask where you heard about them. Please support our show and let them know we sent you. Thinking to ESI, I think one of the harder parts of what he's describing is accepting that something important

[00:11:33] might not need a lot of ongoing work from you. If you're used to getting results by putting in more effort, an approach like index fund investing can feel a little too simple. You might even wonder whether you're being lazy. If you spent some time learning about investing, maybe you feel like you should eventually move on to something more advanced. You started with a few funds, but now you know more, so shouldn't you be doing more?

[00:12:03] But I don't think that necessarily follows. You can still be curious. You can read about an investment without needing to own it or learn about a strategy without trying it with your money. There doesn't have to be a change to your account every time you learn something. And pretty much all the authors we hear on this show agree, and many of them are early retirees. So thank you to ESI for this one. Thank you for being here.

[00:12:32] Have a great day and I'll see you tomorrow where your optimal life awaits.