Index Funds : The ultimate hack for the average investor!
Simplicity, low fees, and peace of mind in the complex world of investing
Hello dear readers,
Apologies for not sharing any articles in the interim period . I will strive for sharing articles more frequently from now on.
Coming to today’s topic, let's face it – investing can be a rollercoaster of emotions and downright confusing. With thousands of options and the pressure to keep up with market trends, it's no wonder many people find it daunting. But what if we told you there's a low-stress, cost-effective, and almost foolproof way to invest?
Before that , can you guess what happened to the stock market index despite multitude of events, recessions, national & international crisis across the world and individual countries say for example in India or US?
India Nifty performance from 2004 (from the Solidarity Jul’ 2021 letter)
P.S - if you have the time , highly recommend reading quarterly letters and blog posts from Manish Gupta at this link.
US Dow Jones (DJIA) Historical chart:
As outlined above, despite all the numerous events, investing in basket of the top stocks would have given a decent return to the investor who just stayed the course!
So what is an index fund?
The Beauty of Simplicity
Index funds shine when it comes to simplicity. An index fund is an investment that mirrors a specific market index, like the S&P 500 in the US or the Nifty 50 in India. By investing in an index fund, you're essentially grabbing a slice of the entire market, which makes for a diversified and low-risk investment.
Rather than trying to outsmart the market by choosing individual stocks, index funds enable you to capitalise on the market's natural growth over time. One of the most significant advantages of index funds is that they inherently possess a winning portfolio. When you invest in an index fund, you're essentially investing in the market's top-performing stocks. Over time, the winners will naturally rise, and the losers will fall, ensuring that your investment continues to grow.
In the words of Warren Buffett, the Oracle of Omaha himself,
If you examine the 35 years since the 1960s ended, you will find that an investor’s return, including dividends, from owning the S&P has averaged 11.2% annually (well above what we expect future returns to be)….Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.
Three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies.
The No-Stress Approach: Let the Market Do the Work
Index funds let you take a breather from constantly monitoring the market or making complex investment decisions. So, why not let the market do the heavy lifting for you?
Index funds allow you to adopt a passive, long-term approach to investing. You can simply invest a fixed amount in an index fund regularly and let the magic of compounding work its wonders. It's like planting a seed and watching it grow into a beautiful tree over time – without the need for constant pruning and fussing.
One famous quote from Sanjay Bakshi (famed professor and value investor in India), who emphasizes on Returns per unit stress in this great article:
Once you start incorporating return per unit of stress in your investment thinking, the trade-offs become obvious. You would start settling for investment situations which offer a satisfactory return per unit of risk and stress over those which offer high returns per unit of financial risk but low returns per unit of stress. You will slow down and start appreciating the slow process of long-term, stress-free compounding as opposed to nerve-wracking, adrenalin laden high frequency operations in the stock market. My advice to those who ignore the stress part of the equation but focus only on returns per unit of risk: You cannot take it away with you, so what’s the point of all that stress, just for the money?
Budget-Friendly Fees: Say Goodbye to Hidden Costs
One of the primary reasons index funds outshine actively managed funds is their low fees. Actively managed funds come with higher fees because they need a team of experts to research and select stocks. However, these fees can significantly impact your returns over time.
In contrast, index funds passively follow a market index and therefore have lower operating costs. That might not sound like a big difference, but over time, those fees can eat into your returns like termites in wood. For example, an investment of $10,000 over 30 years with a 7% annual return will grow to $76,123 with a 0.09% fee, but only to $57,434 with a 1% fee . That's a whopping difference of almost $19,000 or ~25% !
To further illustrate the above, let’s see a 10 year bet which Warren Buffett announced in Dec’2017:
..publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be.
Drum roll ! The S&P index managed to beat five actively managed fund of funds!
Excerpts from the letter below:
Those five funds-of-funds in turn owned interests in more than 200 hedge funds. Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence.
The managers of the five funds-of-funds possessed a further advantage: They could – and did – rearrange their portfolios of hedge funds during the ten years, investing with new “stars” while exiting their positions in hedge funds whose managers had lost their touch. Every actor on Protégé’s side was highly incentivized: Both the fund-of-funds managers and the hedge-fund managers they selected significantly shared in gains, even those achieved simply because the market generally moves upwards.
Those performance incentives, it should be emphasized, were frosting on a huge and tasty cake: Even if the funds lost money for their investors during the decade, their managers could grow very rich. That would occur because fixed fees averaging a staggering 2 1⁄2% of assets or so were paid every year by the fund-of-funds’ investors, with part of these fees going to the managers at the five funds-of-funds and the balance going to the 200-plus managers of the underlying hedge funds.
Summary
For the average investor , index funds provide a simple, affordable, and stress-free approach to investing. With low fees and a passive investment strategy, you can ride the market's natural growth over time without the need to become a stock-picking wizard.
As you embark on your investment journey with index funds, remember that the key to success lies in patience, discipline, and consistency. By sticking to your investment plan and focusing on the long term, you can harness the full potential of index funds and set yourself on a path to financial freedom.
In the words of Jack Bogle, the founder of Vanguard and the pioneer of index fund investing, "Time is your friend; impulse is your enemy”. Happy investing!
NOTE: Please consult your financial advisor for advice before investing in any financial product. Please also note that I am not a registered investment advisor, these articles are for learning purpose only and should not be considered as investment advice.