Mutual funds are without a doubt the most significant invention of the 20th century as far as the small individual investor of modest means is concerned. Thanks to these mutual funds, the benefits of the international capital markets can now accrue to the vast majority of the population and now just the wealthy elite. A special type of mutual fund, called an index fund, represents an important evolution of the mutual fund model, allowing small investors to benefit even more than before.
What Is An Index Fund?
An index fund is merely a mutual fund that seeks to track the performance of a broad market index such as the S&P 500 or EAFE. Unlike traditional mutual funds, an index fund doesn't attempt to outperform the market by making shrewd purchase and sell decisions. Why not? Because as it turns out, most traditional mutual funds fail in their goals to beat the market. As a whole, index funds tend to outperform most non-index mutual funds for a variety of reasons.
Why Do Index Funds Outperform?
The main reason index funds tend to outperform traditional mutual funds over the long term is their very low cost, expressed as a low expense ratio. Since an indexing strategy doesn't need an expensive manager and cadre of research analysts, these funds have an immediate cost advantage of 0.5%, 1%, or more over other funds. As it turns out, a 1% head start is nearly insurmountable in the world of investing: sure, some will manage it but how do you know which ones in advance?
Where To Buy Mutual Funds?
Most of the large fund companies now sell index funds, but not all are created equal. For my money, I consider Vanguard to be the best of the best when it comes to index funds. Vanguard is inexpensive, customer-focused, very easy to deal with, and doesn't charge any transaction or brokerage fees. In fact, you could make a good argument that Vanguard is the only company you need use at all.
