When it comes to stock market mutual funds there are two that clearly stand out as top picks for the average investor, the S&P (Standard & Poor's) 500 index fund and the total market index fund. It is important to understand how these two funds work and what makes them preferable choices for primary investments.
What is a Standard & Poor’s 500 Index or Total Stock Market Fund?
Standard & Poor's Financial Services is an independent stock rating company that has achieved the unique status of being widely considered as the foremost company in its field, so much so that it's analysis has become the standard by which stocks are valued.
The S&P (Standard & Poor's) 500 is their list of the 500 largest companies. A S&P (Standard & Poor's) 500 index fund is a mutual fund that is made up of all these stocks.
A total market index fund is correspondingly a fund made up of all stocks listed on the New York Stock Exchange. In countries other than the US, a similar index fund consists of stocks based on an alternate market, such as the Tokyo stock exchange.
Why Choose These Two Funds?
There are numerous advantages gained by investing in these funds. Consider a few of them.
1st, unparalleled diversification is assured. Stocks from all sectors are included in proportional amounts. You never need to fear declines in particular stocks or even sectors. As a result, you will never be invested in the highest performing stock fund; neither will you be invested in the lowest, which is far more important.
2nd, management fees are extremely low. As I write, for example, Vanguard charges only 0.15% on their total market index fund (one tenth the average 1.5% for all funds). Obviously, fees of any kind deduct from your fund balance. The lower the fees the better.
In addition, index funds like this can be purchased directly from the investment companies making them no load funds. This means there is no brokerage fee involved. With no loads and low management fees you get to have more of your money working for you. This is no small advantage.
3rd, index funds are as close as you can get to guaranteed income from stocks. It is true that the value of your investment can go down when the whole stock market goes down, but with time the market has always gone up even more. Individual stocks can go down and stay, but when you invest in the whole market there is a high level of safety.
4th, index funds outperform most of the funds available for your investments. These funds outperform 60-80% of all mutual funds based on how you figure it (various sources compute differently based on fee considerations, taxes, etc.).
Clearly, no matter how you figure it the odds are against you when you choose to invest in any other type of fund. Everyone thinks they can beat the odds but obviously they can’t. If even 60% of all funds consistently earn less than these index funds, and it is at least that much, a person is betting against the odds to go any other way.
Why Not Choose Other Index Funds?
Now there are a lot of other index funds, so don’t be confused. For example, there are index funds for large cap companies, small cap companies, and companies in almost any sector you can name. In addition, there are index funds for bonds—dozens of them.
These do not enjoy the same advantages of the broader stock market index funds. This does not mean they may not be good investments for the knowledgeable investor, however.
Obviously, if you held an index fund focused on financial stocks in recent months you know that any single sector group of funds, indexed or not, can be more risky than a total market fund. The same is true if you held tech funds a few years ago.
Is a S&P 500 or Total Stock Market Fund Right for You?
My goal for Success With Money is educational. I do not recommend specific investments for anyone. But I have my personal Roth IRA in a total stock market index fund and other money in a S&P index fund. I have a number of other investments, but this is what I have practiced as well as what I think is often best for basic investments.
