Index Funds
No one can accurately predict what stocks or bonds will be the winner before it happens, and certainly no one can accurately predict who will be a winning fund manager before they boast that they are the top fund of the quarter/year. Active managers who say they created a winning mutual fund is a marketing lie. Even if a fund is a top-performing fund for any length of time, the costs of holding that fund versus an index fund almost always cancels out any margin of victory.
There is also a very strong principle of investing called "regression to the mean" where a top-performing fund will almost always (over 90% of the time) regress to the average market returns (or worse, end up at the bottom like many of last year's winners do the following year). Picking last year's top performer is like investing while looking in the rear-view mirror: although it gives an accurate picture of past performance, it gives zero indication of future performance. Active management of a fund (frequent buying and selling of stocks or bonds in an attempt to beat the market average) also means that it takes more resources to manage the fund, i.e. - more money from the individual investor to cover salaries, commissions and higher realized capital gains taxes.
Investment giant John Bogle, founder of the Vanguard Investment Group, is the creator of the world's largest mutual fund and first index fund, the Vanguard S&P 500 Index Fund. John Bogle has numerous National awards and honors as well as receiving 13 honorary doctorates in economics. His philosophy is simple: give the average investor their fair share of the market at the lowest possible cost.
An index fund does exactly as it says - it purchases stocks or bonds proportional to a given index thereby give returns virtually identical to that index. The Vanguard S&P 500 Index fund buys the 500 stocks in proportion to the Standard & Poor 500 index we see on the news (Exxon and Apple represent a greater stock holding than the other stocks in the S&P) and simply follows this index without trying to beat it. This creates a very passive style and also a MUCH less expensive style of investing. Expense ratios for most index funds fall below .5% per year and most Vanguard index funds are below .2% - the lowest in the industry.
There are index funds that purchase the entire US stock market, the entire International stock market, the entire US bond market as well as other caps and sectors of the market. Since it is impossible to predict next year's winners or losers in the stock market, owning the entire US stock or bond market in an index fund creates optimal diversification and your returns replicate that of the entire US stock market minus a very nominal expense. Vanguard has a Total Stock Market, a Total Bond Market, as well as a Total International Stock Market index fund each with expense ratios lower than .2% per year.
Vanguard also offers Target Retirement and LifeStrategy funds, known as "fund of funds," that have Vanguard Total Stock, Total Bond and Total International index funds at their core - each with very low expense ratios - all lumped into one mutual fund. Target Retirement funds are set to a pre-determined target year (2020, 2020, 20230, etc.) and start out with a more aggressive Asset Allocation and get more conservative as the target year approaches. This is great for an investor who doesn't want to rebalance their portfolio or keep track of anything. The only trouble with Target Retirement funds is they are, in my opinion, too conservative at the target year and continue to get more conservative until stock holdings are almost zero. You need both stocks and bonds all the way through retirement to maintain a healthy nest egg. A Vanguard Target Retirement fund is a great starter fund because you only need one fund and the minimum initial investment is only $1,000 and you can add as little as $100 per month in an IRA. Don't pick a target year based on your retirement age, pick one based on your desired Asset Allocation and risk tolerance.
LifeStrategy Funds (offered only by Vanguard) also have Total Stock, Total Bond and Total International index funds at their core and have very low expense ratios, but are set at a fixed ratio of stocks/bonds (80/20, 60/40, 40/60 and 20/80). This is good for someone reaching a certain point of their life and do not want their stock/bond holding to change for a long time (like early in the investing years or in retirement). Vanguard's LifeStrategy funds require $3,000 as a minimum initial investment. Like the Target Retirement fund, LifeStrategy funds are for the investor that wishes to be more "hands-off" and not have to rebalance or mess with anything once they get started.
Index funds are advantageous for several reasons:
1) You can be completely set in just 1 mutual fund for retirement (Target Retirement or LifeStrategy) or 3-4 funds in a balanced portfolio (Total US Stock, Total Int. Stock, Total Bond).
2) DIVERSIFICATION - in as little as one fund, you can own literally thousands of different individual stocks and bonds.
3) Rock-Bottom Costs. Index funds are much less expensive than actively managed funds, and Vanguard index funds are the cheapest in the industry. Remember, COST is the only accurate predictor of mutual fund performance (higher cost = lower return).
4) No worries about picking the wrong stock or mutual fund. Since you cannot guess who will be tomorrow's winning (or losing) fund manager, index funds eliminate the risk of picking a loser.
5) Easy rebalancing - by owning just a few funds (or only one that does it automatically), it makes it easy to rebalance your portfolio to your desired Asset Allocation.
6) Virtually no fund risk - Actively managed funds can and do disappear along with their investor's money. Index funds will be around as long as there is an index.
7) Stock index funds are extremely tax-efficient. If you wish to invest 5 years or more outside of a retirement account for a car, home, or other financial goal, stock index funds are a great place for this as the stocks are only sold at a rate of around 2-4% per year which means low realized capital gains taxes paid each year. Don't buy bond funds outside of a retirement account if you can - bonds pay a steady stream of taxable interest and also mature after 5, 10, 20 years depending on the maturity length which is also taxable.
8) You get your fair share at a low price - exactly what Mr. Bogle initially set out to do when he founded Vanguard.
There is also a very strong principle of investing called "regression to the mean" where a top-performing fund will almost always (over 90% of the time) regress to the average market returns (or worse, end up at the bottom like many of last year's winners do the following year). Picking last year's top performer is like investing while looking in the rear-view mirror: although it gives an accurate picture of past performance, it gives zero indication of future performance. Active management of a fund (frequent buying and selling of stocks or bonds in an attempt to beat the market average) also means that it takes more resources to manage the fund, i.e. - more money from the individual investor to cover salaries, commissions and higher realized capital gains taxes.
Investment giant John Bogle, founder of the Vanguard Investment Group, is the creator of the world's largest mutual fund and first index fund, the Vanguard S&P 500 Index Fund. John Bogle has numerous National awards and honors as well as receiving 13 honorary doctorates in economics. His philosophy is simple: give the average investor their fair share of the market at the lowest possible cost.
An index fund does exactly as it says - it purchases stocks or bonds proportional to a given index thereby give returns virtually identical to that index. The Vanguard S&P 500 Index fund buys the 500 stocks in proportion to the Standard & Poor 500 index we see on the news (Exxon and Apple represent a greater stock holding than the other stocks in the S&P) and simply follows this index without trying to beat it. This creates a very passive style and also a MUCH less expensive style of investing. Expense ratios for most index funds fall below .5% per year and most Vanguard index funds are below .2% - the lowest in the industry.
There are index funds that purchase the entire US stock market, the entire International stock market, the entire US bond market as well as other caps and sectors of the market. Since it is impossible to predict next year's winners or losers in the stock market, owning the entire US stock or bond market in an index fund creates optimal diversification and your returns replicate that of the entire US stock market minus a very nominal expense. Vanguard has a Total Stock Market, a Total Bond Market, as well as a Total International Stock Market index fund each with expense ratios lower than .2% per year.
Vanguard also offers Target Retirement and LifeStrategy funds, known as "fund of funds," that have Vanguard Total Stock, Total Bond and Total International index funds at their core - each with very low expense ratios - all lumped into one mutual fund. Target Retirement funds are set to a pre-determined target year (2020, 2020, 20230, etc.) and start out with a more aggressive Asset Allocation and get more conservative as the target year approaches. This is great for an investor who doesn't want to rebalance their portfolio or keep track of anything. The only trouble with Target Retirement funds is they are, in my opinion, too conservative at the target year and continue to get more conservative until stock holdings are almost zero. You need both stocks and bonds all the way through retirement to maintain a healthy nest egg. A Vanguard Target Retirement fund is a great starter fund because you only need one fund and the minimum initial investment is only $1,000 and you can add as little as $100 per month in an IRA. Don't pick a target year based on your retirement age, pick one based on your desired Asset Allocation and risk tolerance.
LifeStrategy Funds (offered only by Vanguard) also have Total Stock, Total Bond and Total International index funds at their core and have very low expense ratios, but are set at a fixed ratio of stocks/bonds (80/20, 60/40, 40/60 and 20/80). This is good for someone reaching a certain point of their life and do not want their stock/bond holding to change for a long time (like early in the investing years or in retirement). Vanguard's LifeStrategy funds require $3,000 as a minimum initial investment. Like the Target Retirement fund, LifeStrategy funds are for the investor that wishes to be more "hands-off" and not have to rebalance or mess with anything once they get started.
Index funds are advantageous for several reasons:
1) You can be completely set in just 1 mutual fund for retirement (Target Retirement or LifeStrategy) or 3-4 funds in a balanced portfolio (Total US Stock, Total Int. Stock, Total Bond).
2) DIVERSIFICATION - in as little as one fund, you can own literally thousands of different individual stocks and bonds.
3) Rock-Bottom Costs. Index funds are much less expensive than actively managed funds, and Vanguard index funds are the cheapest in the industry. Remember, COST is the only accurate predictor of mutual fund performance (higher cost = lower return).
4) No worries about picking the wrong stock or mutual fund. Since you cannot guess who will be tomorrow's winning (or losing) fund manager, index funds eliminate the risk of picking a loser.
5) Easy rebalancing - by owning just a few funds (or only one that does it automatically), it makes it easy to rebalance your portfolio to your desired Asset Allocation.
6) Virtually no fund risk - Actively managed funds can and do disappear along with their investor's money. Index funds will be around as long as there is an index.
7) Stock index funds are extremely tax-efficient. If you wish to invest 5 years or more outside of a retirement account for a car, home, or other financial goal, stock index funds are a great place for this as the stocks are only sold at a rate of around 2-4% per year which means low realized capital gains taxes paid each year. Don't buy bond funds outside of a retirement account if you can - bonds pay a steady stream of taxable interest and also mature after 5, 10, 20 years depending on the maturity length which is also taxable.
8) You get your fair share at a low price - exactly what Mr. Bogle initially set out to do when he founded Vanguard.