Why You Should Invest in Index Funds: Grow Rich

This article is an excerpt from the Shortform book guide to "The Simple Path to Wealth" by JL Collins. Shortform has the world's best summaries and analyses of books you should be reading.

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What exactly is an index fund? How do index funds differ from other mutual funds?

An index fund is a type of mutual fund containing stocks chosen to replicate the market’s performance. In contrast, actively managed mutual funds are stocks chosen and managed by professionals who attempt to outperform the market.

Here is why you should invest in index funds.

Understanding Index Funds

Index funds like type of mutual funds or exchange-traded funds designed to mirror the market. Various indexes, such as the Dow Jones Industrial Average and the S&P 500, use selected stocks as a measure of how the market as a whole is doing. In 1976, John Bogle, founder of The Vanguard Group, introduced the first public index fund for investors, replicating the S&P 500.

So, why invest in index funds over professionally managed mutual funds?

According to financial blogger J. L. Collins, index funds are much safer than professionally managed mutual funds because they get better results over the long term and have lower feeds. The chances of anyone regularly selecting stocks that beat the market are minuscule, so you can get better results by buying into an index that contains a lot of stocks (e.g. VTSAX Total Stock Market Index covers over 3,700 companies) that grow steadily over time.

By investing in index funds, you can passively grow wealth at the pace of the market.

Collins touts Vanguard’s VTSAX Total Stock Market Index Fund as the simplest and most effective investment for tapping into the market’s wealth-building capabilities. (Collins notes that he isn’t being paid by Vanguard to promote its funds.)

The Controversy Over Index Fund Investing

Index funds remain somewhat controversial in the investment industry. Professionals have denigrated index fund investing ever since Bogle introduced the index fund in 1976. 

The primary reason for the backlash is that because index fund investing is so simple and low cost, it threatens financial industry profits. Money managers, mutual fund companies, and financial advisors make big money by charging investors fees, which they justify by making investment too complicated for you to pursue on your own and by claiming they can outperform the market.

Many financial advisors argue that index funds may be fine for average people who don’t want to work at investing, but that with a small effort and professional advice, you can get better returns (outperform the market). However, Vanguard founder Jack Bogle, who died in 2019, contended that in 61 years in investing, he never met anyone who could do this. 

In fact, research indicates that only around 1% of fund managers outperform the market consistently, although they’re occasionally lucky. In reality, most professional money managers underperform indexes. Over 15 to 30 years, the index will do better than 82-99% of managed funds.

Why You Should Invest in Index Funds: Grow Rich

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Darya Sinusoid

Darya’s love for reading started with fantasy novels (The LOTR trilogy is still her all-time-favorite). Growing up, however, she found herself transitioning to non-fiction, psychological, and self-help books. She has a degree in Psychology and a deep passion for the subject. She likes reading research-informed books that distill the workings of the human brain/mind/consciousness and thinking of ways to apply the insights to her own life. Some of her favorites include Thinking, Fast and Slow, How We Decide, and The Wisdom of the Enneagram.

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