Should You Invest in Index Funds?

Many of us are novice investors and know very little of the ins and outs of Wall Street. I am certainly no Warren Buffett.  In the past 10 or 15 years index funds have become popular investment vehicles to create broader diversification. In order to determine if you should invest in index funds, I think it is important to examine a few areas: defining  what an index fund is, the benefits of having an index fund and what potential downsides could occur.

An index fund is a collection of investments that tries to capture  a specific market standard. For example, you can buy an index fund that mimics a particular industry (think utilities, oil and gas, etc.) or follows the overall stock market. The Vanguard Energy Fund Investor Shares or the Vanguard Total Stock Market Index Fund are some of the most popular investment vehicles in this area. I personally would not invest in the first one because I feel that it is too risky. I try to avoid taking too much risk when it comes to my money. Energy stocks have truly been on a roller coaster. That does not mean the Vanguard Energy fund is bad, but not for me at this moment.

Index funds are an easy way to invest. All a person really needs is a broad stock market fund and a bond fund. You really do not have to research each individual company or do much reallocation of funds. Index funds are truly a passive way of investing. So, if you do not have the time to actively manage your investment, or know very little of stocks, this is the way to go when starting out.

One of the major downsides to index fund investing is you do not always witness astronomical returns. A person is simply trying to keep up with the overall stock market. There is really no flexibility with these funds and stock indexes normally only provide average results. An individual is not going to get rich quick with index funds, but over a longer period of time, I think people can build wealth. You really just have to know upfront that massive gains over night are not going to happen.  Index funds are a safer way of investing.

When I first started investing I chose individual stocks and I have always enjoyed doing the research on picking them. However, I have started paying closer attention to index funds and I have my Roth IRA setup in an index fund. With more financial education, I have become more supportive of index funds. I still love investing in individual stocks, but I do see the benefits of these types of funds. Jim Cramer from the popular television program, Mad Money, argues a person should put their first $10,000 in an index fund before venturing out with individual stock picking. I believe this is smart advice.

Over the years, there is one saying that has remained with me: “diversification is your only free lunch.” It does not  cost anything to be diversified and the benefits of it are wonderful. I guess I just strongly believe when it comes to your hard earned money, a person should always play it safe and invest responsibly. You should never keep all your eggs in one basket. An investor might be able to take more risk when younger, but be mindful of what you are really trying to do; make money! Always think long-term. Just food for thought.

Do you have an index fund? Would you ever consider having one? Remember you should never solely rely on your retirement plan at work. Multiple streams of income is always the way to go if financially possible.

4 thoughts on “Should You Invest in Index Funds?”

  1. I don’t have index funds, I don’t think. I would need to look to see what my money is invested in with my former financial advisor. I know a lot of it is in somewhat aggressive funds (I’m kind of moderate to aggressive when it comes to taking risks with my money). A tiny bit of it is in cash, and part of it is in a more moderate fund. And with my 401(k) at work, that is split between two target date funds. Employers seem to increasingly be less willing to offer a lot of options. At one point, Harvard got rid of tons of options for investing and it seemed like our only options with the companies that worked with our 403(b)s only offered target date funds. For right now, they are working for me. My current employer has their 401(k) with Prudential. Even only having put away about $1000 right now, I can already see the benefit of letting my money work for me rather than the other way around. It’s why even though I make peanuts, I am trying to sock away 7% from each paycheck into that 401(k).

    1. It sounds like you are invested in some type of index fund. My Roth IRA is in a targeted fund. What this fund does is invest in four different index funds: Vanguard Total Stock Market Index Fund Investor Shares, Vanguard Total International Stock Index Fund Investor Shares, Vanguard Total Bond Market II Index Fund Investor Shares and Vanguard Total International Bond Index Fund Investor Shares. This creates a well-diversified portfolio. I also have a retirement plan through the college where I work. I pay 4% and they pay a crazy amount: 19.5% per month. That is why I stay there. I think you are making all the right moves. Keep up the good work.

  2. YES, YES, and more…YES!

    The average investor should focus their search on index funds only. The problem most beginning “investors” have is they’re making “investments” based off of what some friend/family member is telling them. So they aren’t in fact investing, they’re actually gambling. They have no true understanding of what their $$$ is going in to, they are just hoping it hits. The index fund takes all of these risks and throws them out the window. By simply investing in the entire market over time, at the lowest cost possible, you will eventually build wealth.

    You said it perfectly…Know up front that index funds won’t make you rich quick, but they will make you wealthy over time.

    Great post!

    1. I agree that you should take the gambling out of it. I have personally always enjoyed picking individual stocks, but an index fund is important to have. Beginning investors need to focus primarily on index funds. Slow and steady is the way to go. This get rich quick mindset is dangerous. I care about my money and I am not willing to throw my money away like that. Thanks for the comment.

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