I get a ton of questions about portfolio allocation and what people should invest in. To be honest, I will never provide you with any financial advice, even though I am the Financial Geek. Investing is a personal choice and you need to find a strategy that is best for your situation. With that being said, I think index funds are a great way for investors to ease into the stock market. If you are asking yourself: should I put all my money in index funds? This article is for you!
For many investors, putting your money into index funds is a great way to start a portfolio. But it’s not just for beginners. Any investor has room for index funds in their portfolio, no matter how advanced of a trader they are.
So should you put all your money into index funds? It’s not a bad strategy. Even Warren Buffett himself says that for most people, buying low-cost index funds is the best way to invest. If Buffett thinks that way it’s good enough for me! Let’s take a look at some pros and cons of putting all of your money into index funds.
Should I Put All My Money in Index Funds?
Index funds are ETFs or mutual funds that track a particular stock index. The most popular index funds in the world track the benchmark S&P 500 index. Others will track indexes the NASDAQ 100 or the Dow Jones Industrial Average.
So what is so great about index funds? They are easy and add instant diversification to your portfolio. If you buy an S&P 500 index fund you own all 500 companies with much less capital than it would take to buy 500 different stocks. With index funds, you can just set it and forget it.
Considering that the S&P 500 has provided an average annual return of about 9% since its inception in 1957, you can reasonably project your returns from the index fund. At 9% each year, it isn’t a bad place to park your money for some safety and decent returns. Here are some of the pros of owning index funds with your money.
The Pros of Putting All Your Money in Index Funds
The key to index funds is diversification. As I mentioned, you own a little piece of every company in that index. Sure, there will be some companies you do not want to own, but for the most part, owning the entire stock index isn’t a bad thing. Owning the entire S&P 500 in your portfolio is nearly impossible without index funds!
Index funds also typically come with low fees. When we talk about fees for ETFs or mutual funds, we are referring to the MER or Management Expense Ratio. These are a percentage of your total investment that you must pay to the fund provider. For index funds, these fees can be as low as 0.04% which means you pay $4.00 for every $1,000 you have invested. Since index funds require little management, the fees are lower than an actively managed fund. This can help you keep more of your long-term gains.
These funds also typically have a lower risk to your portfolio. Since the fund is diversified, you will not be subject to any volatile price swings on a day-to-day basis. Most stock indexes are fairly stable and have a long history of consistent returns.
Another benefit of investing in index funds is that you can also earn dividends. Many companies in the S&P 500 pay out dividends and if you hold the fund that they are a part of, you will receive a portion of those dividends. This can be a great way to supercharge your index fund investments. Reinvesting those dividends will accelerate the growth of your investment.
The Cons of Putting All Your Money in Index Funds
To be frank, it can be a little boring. But for many people, that is exactly what they want: a boring, passive way to grow their money. Most people simply do not have the time to research companies to buy individual stocks. Owning an entire index is a great way to not have to worry about what you are invested in.
Remember when I said they have lower risk? Well, in the investing world, when you have a lower risk you tend to also have lower returns. With index funds, you won’t generally see a 5% drop in your portfolio value. But at the same time, you do not get the massive surges or excess returns that you can potentially see from individual stocks. Index funds track the index, so you really aren’t going to see a lot of movement in either direction.
With an index fund, you are at the mercy of the market. Having all of your money in one basket can be bad when we hit a bear market. You could potentially lose a large percentage of your gains in a short period of time. Most people who own strictly index funds likely do not have any hedge in place either. For beginner investors, this is where it can be dangerous to put all of your eggs into the index fund basket.
For Canadian Readers: Do Dividends Count as TFSA Contributions?
The Bottom Line: Should I Put All My Money in Index Funds?
The construction of your portfolio is always a personal choice. I will reiterate that for many people, index funds are a great way to get your feet wet in investing. They provide great diversification, safety, and simplicity to your portfolio. But should you ever put all of your money into one asset? I would diversify among different index funds if you can. You never know when a market crash is around the corner!
I hope you found this article interesting!