Index funds and investing for decades

Picking winners is hard

You now know how to read a company: earnings, growth, P/E, debt and cash. Even so, picking the one company that will beat all the others is really hard.

Even professionals mostly fail at it. S&P, the company that runs the S&P 500, checks every year how professional stock-picking funds did. Over 15 years, close to 9 out of 10 US funds that buy big companies did worse than the plain S&P 500.

Buy the whole haystack

There's an old saying: don't look for the needle in the haystack, just buy the haystack.

An index fund buys every company on a list, called an index. One share of an s&p 500 index fund gives you a small piece of about 500 big US companies. Many index funds are ETFs, so you can buy them like a stock.

How an index is built

Most big indexes are weighted by size, by market cap. Bigger companies get a bigger slice. In recent years, the 10 biggest companies in the S&P 500 have made up more than a third of it. So "owning the whole market" still means a lot rides on the giants.

There are many other indexes: the whole US market (thousands of companies), the Nasdaq 100, companies outside the US, and bonds.

Why many people use index funds

1. Diversification. One company failing barely matters.
2. Low cost. Every fund charges a yearly fee called the expense ratio. Some big S&P 500 index funds charge about 0.03% a year. That's $3 for every $10,000. Many stock-picking funds charge 0.5% to 1% or more, which is $50 to $100 for every $10,000, every single year. Over decades, that difference snowballs.
3. No guessing. You don't need to know which pizza chain will win. You own all of them.
4. Time. You can hold it for decades without checking it every day.

A little history

In 1976, John Bogle, who started the fund company Vanguard, launched one of the first index funds that regular people could buy. Lots of people in the industry laughed and called it "Bogle's folly." Today, trillions of dollars sit in index funds.

What the past shows

From 1926 until today, big US stocks have grown about 10% a year on average, counting dividends. After inflation, that's about 7% a year.

But that's an average over almost 100 years. Some years were up more than 30%. In 2008, the S&P 500 lost about 37%. From 2000 to 2009, US stocks went basically nowhere for a whole decade. The past doesn't promise the future.

Investing for decades

The index investor's plan is boring on purpose: own a broad index fund, keep adding to it, hold it for decades, and don't panic in crashes. The math is easy. The hard part is sitting still when the news is scary and everyone around you is selling.

Remember

• An index fund owns every company on a list, like the S&P 500.
• Most professionals fail to beat the index over long periods.
• Low fees matter, because they come out every year.
• US stocks have averaged about 10% a year over the long run, with big drops along the way and no promises.