The beauty of investing in index funds

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Index fundsBack in 2007, Warren Buffett – one of the world’s most successful investors – waged a bet that over 10 years, an S&P 500 index fund would outperform ten hedge funds of the taker’s choice. The sum to be invested was $1 million, with the proceeds going to charity.

The bet was taken up by Protégé Partners, a New York money management firm. It selected five funds of hedge funds, while Buffett chose the Vanguard 500 Index Fund Admiral™ Shares.

From when the contest began on January 1, 2008, through to the end of 2015, according to Fortune, the index fund has returned a cumulative 65.67%, compared with 21.87% for Protégé’s choices.

And while the bet still has until the end of 2017 to run, at this stage, Buffett looks to have an unassailable lead.

So what is an index fund and what advantages does it offer?

An index fund is a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500).

Investing in an index fund is regarded as a form of passive investing. Choosing to invest this way is predicated on the view that it is difficult – if not impossible – to outperform the market on a consistent basis through active investing (picking and trading individual stocks).

Index funds offer several advantages to investors. Typically, they are lower in cost (compared with actively traded funds), and they offer a way for investors to diversify with relative ease.

A key reason index funds are relatively less expensive is that unlike active investment, they don’t require teams of researchers and analysts to assist in stock selection. This means index funds generally have lower expense ratios, meaning investors have more of their capital working for them.

And because index funds are comprised of numerous underlying investments, risk is not concentrated in a single stock. This helps to build diversification into an investor’s portfolio.

Index funds on the rise

It’s interesting to note that investing in index funds has grown in popularity over recent years.

In fact US investor website, Investopedia, says:

“With index funds outperforming their actively managed counterparts on a large scale, asset flows have grown significantly in index fund products. For the 12-month period ending May 2016, investors poured more than $375 billion into index funds across all asset classes. Most of that money came at the expense of actively managed funds, which experienced outflows of roughly $308 billion during the same time frame.”

At 5 Financial, we often recommend that our clients utilise index funds as part of their investment strategy. Naturally each client’s situation and goals are different, and we tailor our advice accordingly.

If you’re interested in finding out more about whether investing in index funds is right for you, please schedule an appointment with us today. An initial consultation is offered at no charge and without obligation.


Please note, this article is of general nature only. It does not take into account your specific circumstances and goals. We strongly recommend you seek professional advice before acting on any information.

2018-01-22T08:14:24+00:00 December 12th, 2016|