Buy Index Funds

Index funds are a basket of stocks rather than an individual stock. Vanguard alone offers over a 100 index funds. Some of them are focussed on sectors such as energy or technology, others on geography such as Europe or emerging markets, and others based on company size such as small/mid/large market capitalizations. So which one of these 100 should you buy?

I recommend a total market index. Such an index owns a piece of every public U.S. company. Further, it owns them in the ratio of their market capitalization so valuable companies such as Apple, Tesla, or Microsoft will form a larger fraction of the index fund than less valuable companies such as American Airlines or Williams Sonoma. An index fund averages out the winners and the losers and as long as the economy does well, the index fund will go up over time. In many ways, an index fund is a bet on the US economy. Now, people have been predicting the decline of the dollar - and by extension that of the United States - for a long time now and it has yet to happen. And if and when that does, a lot of other things will also be in deep trouble so in some ways this bet on the entire US economy is a much safer investment than individual stocks.

An index fund that tracks the S&P 500 i.e. the 500 largest companies is also very similar to the total market index funds. The performances of these funds whether S&P 500 or total market are almost exactly the same.

Here are the best-known total stock market index funds:

Here are the S&P 500 index funds: Fun fact: the Top 10 holdings i.e. 2% of the 500 in Vanguard's VFIAX fund account for fully 30% of its net assets. Of these, the top 3 - Apple, Microsoft and Amazon - are worth more than the next 7 combined. Since the index funds' holdings are weighted by the underlying companies' market capitalization, the 500 companies that form the S&P 500 constitute nearly 100% of the total stock market's capitalization. In other words these two funds - S&P 500 and Total Market - track very closely to each other in terms of performance because both of them contain the stocks that have the greatest weight in their composition.

Index funds are also low-cost because they don't have to spend a lot of money hiring fancy fund managers who have to make risky bets in trying to pick winners and losers. They are just adjusting the index fund holdings to reflect at the end of each trading day, what happened to the individual stocks on that day. This is the "passive" part. And this cost of managing the fund is called an "Expense Ratio" or ER in the industry. All these companies are requried by law to show you, the customer, what each funds's ER is - pay attention to it! The above funds all have ERs in the 0.02-0.04% range. This means that for every $100 invested in them the company charges you 2-4ยข for management. Avoid, or at the very least, be very skeptical of index funds with higher ERs. Once you start to see ERs of 0.25 or higher (some go to 1.5%) you are really paying for some rich hedge fund manager's 2nd home in the Hamptons or their 3rd yacht. Beware!

Alright! By now you have saved up, paid off your debts and started to put money in index funds. Should you buy every time the market falls? Should you sell after a strong year? What should you do? Decisions! Decisions! I recommend that you avoid attempting to time the market and just make automatic investments.