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Index Funds are still the best way to buy stocks
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The argument in favor of index fund investing is stronger than ever. Today's investors want to play a bigger role in determining their financial future, and when it comes to purchasing stock funds, the easy answer is indexing.
The cost factor
Index funds cost less because they are not actively managed. The cost savings can add up to many thousands of dollars over a lifetime of investing.
Over time, most managed funds under-perform index funds because they have an additional hurdle. First, they must meet the market performance automatically attained by index funds, AND they must beat the market by an amount equal to the larger management fees they charge their investors.
If the market rises 7% in a year, a fund that charges a 2% management fee needs to rise 9% to be equal. There are index funds with fees as low as .10% – the hurdles are significantly different.
Managed funds are not always totally invested
Another timely rationale for selecting index funds over managed funds is the fact that many active fund managers are presently holding large amounts of cash in reserve, which means their shareholders who think they are fully invested in the market, are not.
One major reason for the cash reserve is they are waiting for the “right time” to buy. Conversely, other experts advise that it is a bad idea for anyone to try to time the market.
If you are not investing in the market during bad times you will miss the greatest gains, which usually take place in the earliest days of a new bull market. Purchasing shares in a total market index fund - on a regular basis - is an easy way to profit from the eventual market turn.
A conservative investment approach utilizing index funds
Investors that have come to believe that the present upside opportunity in the stock market is greater than the current downside risk – should consider the following.
Buy inexpensive index funds
Select a total market index fund such as the Vanguard Total Stock Market Index Fund (VTSMX), or the Fidelity Spartan Total Market Index Fund (FSTMX). The stocks held by these funds cover the entire market in three segments: 70% large companies, 20% medium sized companies, and 10% small companies (figures are approximate). Fund holders own a piece of all of them. When the entire market starts to move up, so does your investment.
Total market index funds are currently yielding about 2.5%. That means the investor has an opportunity to earn dividends at a yield greater than the interest offered by many CD's and money market accounts whose earnings are taxed as ordinary income. Moreover, there is the very real opportunity for significant capital gains as the stock market recovers.
Own a piece of the world market
The total market index investor really owns a piece of the global market. Many of the US companies held in any total market index portfolio have significant international exposure in established as well as developing countries.
Buy low and sell high
The equity market is far below its high of October 2007. History tells us that sometime in the future the market will reach and probably exceed its earlier high mark. If you are not a stock investor, now is the time to start - especially if you are young.
Stock market investing is still a risk
Yes, it is a gamble, and the market could sink further, but at this point – it’s a good gamble. There are many talented people around the world working on, and expecting an eventual bull market. Shouldn't you be one of them?
There are index funds for every corporate classification. Large-cap, large-cap value, small-cap, and small-cap value, etc. The total stock market index fund is always weighted toward large cap stocks because of their relative capitalization. Investors can mix and match index funds, but the total market funds are the simplest solution to easy investing in the broad stock market.
Before you make any sizable investment learn how it will affect your personal situation. Seek the advice of your tax and/or financial planning counselors.
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