“Gunning for average is your best shot at finishing above average.” – John C Bogle

What are index funds?

STOCK MARKET INDEXES

Stock market indexes track the performance of a certain group of stocks. You must have heard of stock market indexes such as S&P500. S&P 500 index includes 500 leading publicly traded companies in the U.S.Each company makes up a fraction of the index proportional to its market cap. For example Apple is about 7% of the market and it makes up 7% of the index. Similarly Tesla is about 1.5%, Walmart is 0.6%, etc.

Source: finviz.com

INDEX FUNDS BUY STOCKS CORRESPONDING TO THE BENCHMARK INDEX

An Index fund is a mutual fund that tries to match the performance of the index it is tracking by buying each company’s shares in the same proportion as the index. For example, an S&P 500 fund would have 7% of its money invested in Apple shares, 1.5% in Tesla, 0.6% in Walmart and so on.

DIFFERENT TYPES OF INDEXES

There are many different types of indexes including sector specific indexes, but the ones that are of most interest to the FIRE community are the “Total Stock Market Index” funds. In the US, these include all the approximately 4000 stocks that are traded in the market. Internationally, there are “All World Indexes” that provide additional diversification.

WHY INCLUDE IT IN YOUR FIRE PORTFOLIO?

Index funds have a number of advantages including diversification, very low fees and low churn rate. Over the long term, even experienced stock pickers find it difficult to match the performance of index funds. Thats why these should make up the core of your FIRE portfolio!