How index funds work: why doing nothing beats most experts
What is an index fund? The fund that buys every company on a list and picks none
An index fund has no expert who hunts for the best companies, and it never tries to find the next winner. So what does it buy, and why do millions of people put their savings in one?
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1
You and Miva start as new teachers at the same school, in the same week. You each have $10,000 to put away for the next 30 years. Neither of you wants it to sit in a drawer.
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2
Then Rono drops by. He was in your class at school, and now he runs a famous fund. A fund collects money from many people, and a fund manager like Rono decides what to buy with it.
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3
What Rono buys are shares. A share is a small piece of a company. When the company does well, people pay more for its shares, and the owners gain.
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4
Rono's team studies hundreds of companies and keeps only about 40, the ones it thinks will do best. That is the job Rono is famous for: picking.
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5
Now forget the picking and look at a list. The S&P 500 is a list of 500 large American companies. A list like this is called an index. When its companies are worth more, the index goes up.
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6
An index fund buys a small piece of every company on the list. Nobody in it picks a winner. Nobody throws out a loser. Whatever the 500 companies do together, the fund does too.
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7
Miva gives her money to Rono's fund. You put yours in an S&P 500 index fund. "Your fund will only ever be average," Miva laughs. "Rono will beat it."
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8
So you agree on a test. Every June, you will both pin your yearly statement on the staff room noticeboard, for everyone to see.
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Go further
Three more names.