Founder and former CEO of the Vanguard Mutual Fund Group, John C. Bogle, is known for his firm belief that the best place for an average investor to put their money is in an index fund.
But some index funds are better than others, explains the author of “The Little Book of Common Sense Investing.”
There are hundreds of choices out there — “large cap, mid-cap, small-cap, industry sectors, international, single country, and so on,” he writes — making the process confusing for potential investors.
To find the best one for you, pay attention to one thing, Bogle says: the cost of the fund.
“If investors could rely on only a single factor to select future superior performers and to avoid future inferior performers, it would be fund costs,” Bogle writes. “The record could hardly be clearer: The more the managers and brokers take, the less the investors make. So why not own an index fund with no active manager and no management fee, and with virtually no trading of stocks?”
While there are options out there that carry expense ratios (the industry term for these fees) as low as .10%, others have expense ratios as high as .80% and require you to pay a standard brokerage commission.
“All index funds are not created equal. While their index-based portfolios are substantially identical, their costs are anything but identical,” Bogle explains. “The gap between the costs charged by the low-cost funds and the high-cost funds offered by 10 major fund organisations for their S&P 500-Index-based funds runs upward of an amazing 1.2 percentage points per year.”
That may not seem like a significant difference, but the little fees add up in an astonishing way, making it even more crucial to pick low-cost index funds, Bogle says.
He explains what happened when the same amount of money ($US10,000) was invested in two different index funds in 1984: the Vanguard Index 500 Fund (expense ratio of 0.28% at the time of the investment) and the Wells Fargo Equity Index Fund (expense ratio of .80% at the time of the investment), which also had an initial sales charge of 5.5%.
“These seemingly small differences added up to a 23% enhancement in value for the Vanguard fund [by 2005]. An original investment of $US10,000 in each produced a profit of $US122,700 for the Vanguard 500 Index Fund, compared with $US99,100 for the Wells Fargo Equity Index Fund.”
You can find a fund’s expense ratio, the minimum investment required, and other helpful information about index funds by searching them on in the “quote” field on Morningstar.
For example, here’s Morningstar’s report for the Vanguard 500 Index Fund:
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