And thats being hard on the Peugeot.
Index funds are the exact opposite of sexy. I would day for three reasons:
They are not risky…
They amass returns slowly…
They are boring…
Leaving that aside however, a careful investment strategy using index funds can easily lead the path toward financial independence, freeing up time for other activities.
That is far more sexy.
What is an index?
Before we explain the index fund, lets go over the index itself. An index is a measurement of an entire market’s performance – there are many.
e.g. The MSCI World Index is an index that tracks the performance of the best companies in the world.
The S&P 500 tracks the performance of the best 500 large cap companies in the US.
The names S&P and MSCI are the names of the indexing companies. These indexes track the overall performance of all the stocks within an marketplace. By measuring a companies performance against the index, they can determine if a company has performed above average. ;
What is an index fund then?
An index fund is a basket of different stocks that tracks certain indexes. The most famous (and least sexy) index fund is the S&P 500 tracker fund made by Vanguard (link). The S&P 500 index is favoured by Warren Buffet and recently the founder of the company received an acknowledgement from Buffet himself.
The logic behind choosing a bundle of stocks from an index is simple. It has been proven many times over that active managers struggle to outperform the marketplace over time – well, 86% of them to be exact.
…so if you can’t beat them, join them..
So the index fund tracks all of the best companies in America through the S&P 500 and bundles it together for you into a fund.
But, making a return and outperforming managers is sexy – I don’t get it?
Well, here’s the thing. I.F. are not flashy whatsoever.
They are not as glamorous as the incredible returns found in Venture Capital, or Private Equity supposedly. That is because they require long-term thinking.
But all other industries are far more prone to booms and busts
The most powerful use of the I.F. is reinvesting the income that you receive from the fund each year. When you start re-investing your dividends, you create a compounding effet that greatly increases your holdings value over time.
But that is exactly the point. This effect takes a very long time to develop and in the meantime, VC funds or PE houses will be posting savage returns while you sit at home with yout tracker without any beautiful women trying to be your friend because your rich – like a loser.
Over long periods of time however, the I.F.has proven to be very successful at beating most actively managed funds, (Private Equity, Hedge Funds, Stock Managers etc) it can be pretty powerful.