Are index funds enough?
Index funds can be an excellent option for beginners stepping into the investment world. They are a simple, cost-effective way to hold a broad range of stocks or bonds that mimic a specific benchmark index, meaning they are diversified.
If you're new to investing, you can absolutely start off by buying index funds alone as you learn more about how to choose the right stocks. But as your knowledge grows, you may want to branch out and add different companies to your portfolio that you feel align well with your personal risk tolerance and goals.
Over the long term, index funds have generally outperformed other types of mutual funds. Other benefits of index funds include low fees, tax advantages (they generate less taxable income), and low risk (since they're highly diversified).
Index funds are popular with investors because they promise ownership of a wide variety of stocks, greater diversification and lower risk – usually all at a low cost. That's why many investors, especially beginners, find index funds to be superior investments to individual stocks.
In 2020, Buffett said that “for most people, the best thing to do is to own the S&P 500 index fund, adding “People will try to sell you other things because there's more money in it for them if they do.” This no-frills investment strategy is one of the best for ensuring long-term, low-cost gains.
It's easy to see why S&P 500 index funds are so popular with the billionaire investor class. The S&P 500 has a long history of delivering strong returns, averaging 9% annually over 150 years. In other words, it's hard to find an investment with a better track record than the U.S. stock market.
Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).
While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.
While index funds are free from the fund manager bias, they are still vulnerable to the risk of tracking error. It is the extent to which the index fund does not track the index. Tracking error may occur in an index fund due to liquidity provisions, index constituent changes, corporate actions etc.
Lack of Global Diversification
The S&P 500 is all US-domiciled companies that over the last ~40 years have accounted for ~50% of all global stocks. By just owning the S&P 500 you miss out on almost half of the global opportunity set which is another ~10,000 public companies.
Do index funds ever fail?
While there are few certainties in the financial world, there's virtually no chance that an index fund will ever lose all of its value. One reason for this is that most index funds are highly diversified. They buy and hold identical weights of each stock in an index, such as the S&P 500.
Are Index Funds Safe Long-Term? The short answer is yes: index funds are still safe in the long term. Only the right index funds are safe. There may be some on the market that you want to avoid.
While they offer advantages like lower risk through diversification and long-term solid returns, index funds are also subject to market swings and lack the flexibility of active management.
Warren Buffet's 2013 letter explains the 90/10 rule—put 90% of assets in S&P 500 index funds and the other 10% in short-term government bonds.
How long can you invest in index funds? Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks.
Bitcoin. Buffett is also not a fan of Bitcoin, as he has rather forcefully reiterated on several occasions. Buffett, talking at the Berkshire Hathaway 2022 shareholder meeting, said that, “if you … owned all of the bitcoin in the world and you offered it to me for $25, I wouldn't take it.
The short answer is a resounding yes. Let's take a look at why this is. While past investment performance doesn't guarantee future results, the return of S&P 500 index funds has been about 9% to 10% annualized per year over long periods, depending on the exact timeframe you're looking at.
| Rank | Asset | Average Proportion of Total Wealth |
|---|---|---|
| 1 | Primary and Secondary Homes | 32% |
| 2 | Equities | 18% |
| 3 | Commercial Property | 14% |
| 4 | Bonds | 12% |
Still, there's good news from this chart: With the right investing discipline, a solid index fund and time, there's a good chance you can become a millionaire, even if you understand little about the stock market. In fact, if you follow this plan, it may be difficult to avoid becoming a millionaire.
Another reason some investors don't invest in index funds is that they may have a preference for investing in a particular industry or sector. Index funds are designed to provide exposure to broad market indices, which may not align with an investor's specific interests or values.
Is it better to invest in multiple index funds or just one?
Yes, it can make sense to invest in multiple index funds as part of a diversified investment portfolio. Diversification is an important investment strategy that can help reduce overall risk and increase potential returns.
The biggest difference between investing in index funds and investing in stocks is risk. Individual stocks tend to be far more volatile than fund-based products, including index funds. This can mean a bigger chance for upside … but it also means considerably greater chance of loss.
Exchange-traded funds (ETFs) and index funds are similar in many ways but ETFs are considered to be more convenient to enter or exit. They can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange.
Any kind of stock market-based investing involves risk. An index fund that owns dozens, if not hundreds or even thousands of shares, is better diversified than a portfolio that holds just a handful of securities. In the example of a stock index fund, each company would have to fail before investors lost everything.
Investing in funds, such as exchange-traded funds and low-cost index funds, is often less risky than investing in individual stocks — something that might be especially attractive during a recession.
