What if I told you that there was a way to buy an interest in all of the best companies, and you didn’t need to have millions of dollars available to do it. Would you do it? Well, let us start changing your worldview!
It has always surprised me how little information schools give us regarding the different investment types and how we can use them. I am wanting to break down that confusion for you today. We are going to remove the shroud and give you an in-depth look at what index funds are!
A few things that we are going to discuss in this article
- What are Index Funds?
- History of Index Funds
- What is Passive Investment
- Pros and Cons of Index Investing
- Why Index Funds Should Be Part of My Portfolio
Are you ready to dive in and see what is under the hood of an index fund? Let us get going!
What Are Index Funds Anyway?
So let us just give a quick breakdown of what an Index Fund is. The term is tossed around in retirement investing circles all over. If you don’t have any idea what they’re talking about, you will after this post.
An index follows the movement of various indexes that are out there. The biggest ones you’ve likely heard of are the Dow Jones Industrial Average and the S&P 500. When you invest in an index fund that follows specific indices, you’re actually investing in a fund that holds a sampling of the market securities in that index.
If you invest in VOO (Vanguard S&P 500 ETF), you invest in 509 stocks that are part of the S&P 500. The fund with Vanguard and other companies attempt to mimic the indices they follow. They do this through their own proprietary sampling. They can give you index-linked returns without having to pay the hefty fees you have inside of many actively traded mutual funds. We’ll talk about Active and Passive mutual funds later.
History of Index Funds
There is so much talk about index funds in the markets today. In reality, index fund investing is still a pretty new sensation when investing in the markets. John Bogle invented the concept back in 1975, and the idea baffled many investment companies.
John Bogle is also the father of Vanguard Investments. If you’ve ever looked into the FIRE community, Financial Independence Retire Early, you would hear them speak about the different Vanguard index funds that they use.
Bogle wanted to take a different approach to invest so that the common man had a chance to compete with the pros on Wall Street. He created the funds to provide stable returns for clients while keeping down the costs.
According to officialdata.org, The S&P 500 has averaged roughly 8.22% year over year since 1975. When most advisors tell you they hope to get you 5% – 7% returns while taking on a good deal of risk, this looks pretty great. Psst, you also pay a fraction of the fees.
I’m not saying financial advisors aren’t valuable. They are great for clients who have no idea how to get started and have no desire to be involved in learning to invest. You are really paying an advisor to coach you and keep you accountable.
But for those of us that want to take our futures into our own hands, index funds are a fantastic tool to help you achieve financial freedom.
Regardless, Index funds were created to put you, the average person, in charge of your financial future. Even one of the Godfathers of modern-day investing, Warren Buffett, said that ‘For most people, this is the best thing’ to own. He was referencing the S&P 500 index fund.
What is a Passive Investment?
So, back to our earlier conversation between Active and Passive investments. Active investments can trade in and out of individual companies. Many mutual funds like to have this ability as it allows them to hedge their risk and reposition assets during a volatile market.
In theory, Active investing allows you to sell companies that are no longer performing. This lets you quickly sell off underperforming companies so you can minimize market losses. While that is a great perk, it does come with some downsides. Specifically, their average returns can be lower than the S&P 500, and their costs are generally substantially higher. You could be looking at anywhere from 1 – 2% in total fees, if not higher.
Passive investing is the opposite. Instead of actively buying and selling stocks in and out of the fund, they buy it and sit on it. They typically make changes necessary to rebalance portfolios, but this allows the companies to keep costs extremely low.
With the VOO fund, your expense is .03%. If you compare a $100,000 investment, you could pay close to $2,000 in fees annually with an active mutual fund. In the Vanguard fund, it will be roughly $30.
What are the Pros and Cons of Index Investing

Pros of Index Funds
So as you can see, there are some great benefits to index funds. Specifically, the low fees allow more and more of your assets to compound over time. This not only increases the amount you have saved but also significantly decreases the amount you’re paying out. Over 30 years, this can have a considerable impact on your portfolio.
Index funds are usually spread over hundreds of companies. This gives you natural diversification. The likelihood that all of these corporations will go to zero is negligible. Whereas, when you invest in a single stock, you could have a high probability that something could happen.
Seeing returns at 8% or greater for 30 years is also essential. In the book Money: Master the Game, Tony Robbins wrote that Index funds outperform 97% of mutual funds. You have a 3% chance of picking a mutual fund that will consistently beat the S&P – and you have to pay the fee to invest in it.
Last, you have consistency in your returns. You’re not going to get 500% returns in 6 months in the S&P 500. You can feel confident that you’ll get a steady 8% year over year, though. That is a nice feeling to have.
Cons of Index funds
The investment is boring. What do I mean by that? Well, you just set it and forget it, really. You aren’t actively trading it. You’re not seeing 100% returns on the day. It isn’t going to get you excited. You just put your money into the investment consistently and let it do its own thing.
You won’t be knocking anything out of the park. Unlike angel fund investing, which has considerable risk and substantial reward opportunities, index funds won’t typically have the ability to change your life overnight. They can change your life, though. One of my favorite quotes is, “Most people overestimate what they can do in a year and drastically underestimate what they can do in a decade.”
Indexes don’t really have a hedge during volatile markets. Active investing will hopefully provide downside protection by reallocating investments. Passive investments don’t have anything to stop the downward swing. It isn’t uncommon to take a 15% hit in a down market. We’ve seen much higher losses than that.
Why You Should Have Index Funds in Your Portfolio
Here is the truth. Index funds are boring, as we talked about. But they’re also reliable. You won’t have to worry about losing all of your money or speculating. That can be fine and dandy for a small portion of your portfolio but not for your life savings.
When you add in the Power of Doubling, you can see that an 8% return affords you to double your money every 9 years. This is a pretty solid return for such low fees, and you can truly set it and forget it until you get closer to retirement.
You can add in bond indexes to help with some of the downside risks, and it is also a low-cost investment strategy. By combining these two types of investments, you can create a balanced portfolio. I repeat, this portfolio is as dull as it can be, but you won’t have to worry about it so long as you don’t react to emotion.
Final Thoughts
We talked in-depth about what Index funds are, why you should invest in them, and what some of the pros and cons are. I hope that I’ve given you enough information to start researching on your own, but you’ll find some sample portfolio’s in this post here.
If you want to build a successful retirement portfolio, you need to create the foundation first. Boring is good. Boring is your foundation. Let the index funds be the foundation of your new portfolio. Then, put a small amount of your investable cash towards riskier ventures if you have the stomach for it.
Disclaimer: JustMyLittleMess does not provide tax, investment, or financial services and advice. The information is presented without considering the investment objectives, risk tolerance, or financial circumstances of any specific investor. It might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.