The Rational Investor: Should I Invest in Index Funds?

By Jeremy Sorci | December 22, 2017

When you're saving for retirement, how do index funds factor into your financial strategies?  Our retirement investment advisors often field questions about index funds and how they work with long-term strategic wealth management. 

Jeremy Sorci is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt CountyWhile index funds may not be the most glamorous type of investment, we believe they're an essential component in your comprehensive financial plan. Here's why. 

Index Funds vs Active Management: Investment Guidance

It's no secret that the wealth advisors at Premier favor a passive investment approach. After all, multiple studies and years of real-world evidence underscore the fact that passive investing is key to a truly diversified portfolio that helps you avoid unnecessary fees and expenses that eat away at your returns. 

Unfortunately, many Americans continue to follow active management strategies when saving for retirement — and the fees and costs associated with actively managed mutual funds reduce return. Recent research indicates a significant difference in returns between index funds and actively managed funds for retirement. For instance, at an annual market return rate of 7 percent, a worker who invests 10 percent of his $30,000 per year salary into a passive index fund for 40 years, assuming a 3 percent annual raise, would have more than $925,000 at retirement. 

The same amount saved in an actively managed fund would yield just over $560,000... a significant difference that's all due to the costs and fees associated with active management. In fact, studies show that a typical two-earner household pays more than $150,000 in fees over the lifetime of an actively managed 401(k)!

Jeremy Sorci is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt CountyRetirement Planning Advisors Discuss Index Funds

Focusing on index funds may offer a number of advantages to the rational investor. Passive investment strategies lead to diversified portfolios, as index funds can mirror the performance of an entire range of asset classes. This means built-in protection against market volatility, as your assets are distributed across classes. (In other words, all your eggs aren't in one basket.)

Keep in mind that, historically, the market hasn't lost out. Though passive investing might not be as "exciting" as stock picking, it's a lot less risky... and less costly. Speaking of stock picking, an active investment strategy results in more portfolio turnover, which in turn leads to more fees. In contrast, an index fund helps you to avoid these fees by making it easier to stick with your long-term plan. It's easy to react emotionally to market ups and downs, but a passive investment strategy helps you stay the course and remain disciplined. 

Instead of worrying about the next big "winning" stock, index funds allow you to invest across the market, avoiding the high costs of portfolio turnover. If you choose index funds with low (or no) transaction fees, you can save even more. 

Speak with your retirement plan fiduciary to determine which index fund strategies are right for your retirement plans and long-term goals. 

Posted in The Rational Investor, Investment Guidance