A beginning investor asks, “What is index fund investing?” Walter Lenhard of Vanguard Equity Investment Group explains that in general indexing offers a low cost, diversified way to gain exposure to the markets. It’s a short video answer and reading the transcript might be quicker, but it’s important to learn why index funds must make up at least the majority, if not the entirety, of your investments.
Transcript of What is Index Fund Investing?
Elizabeth: Let’s get to our first question, which I believe is a great introduction to our topic today, indexing. Nadia from Chapel Hill, North Carolina is asking, “My knowledge of index fund investing is very limited. I would appreciate a quick overview,” so Walter, I’m going to have you kick off with that question.
Walter: Traditionally, actively managed mutual funds hired an expert portfolio manager, and it was his job to figure out what the best securities were to go out and buy. Index funds don’t operate like that. Index funds simply track a third party index, so companies such as S&P, Dow Jones, Russell create a list of securities that represent the stock market, and it’s Vanguard’s portfolio manager’s job to go out there and just buy the exact same names that are in those indexes. It’s a little counterintuitive that an unmanaged portfolio would beat an actively managed portfolio that’s run by an expert.
Academics, back in the 1970s, studied the performance of most actively managed mutual funds, and what they noticed is most of them actually underperform the stock market in general, so they wrote a few white papers, and they made a call to the industry to go out there and produce an investment product that would just simply track the performance of the stock market, and that’s what Vanguard did in 1976. We launched the first retail S&P 500 mutual fund, and since then, it’s grown to be one of our flagship products with a very impressive performance record.