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Compounded over the years, such small savings can add up to big money.

Advice for Investors | Using index funds as investment strategy - Advice for Investors


Index investing is therefore simply the process of using index funds to build a passive investment strategy. Index investing is an incredibly effective strategy. That is, in the vast majority of cases, simply taking the market returns produced better results than trying to beat the market. But how can that be true? How can such a simple strategy produce such positive results? As it turns out, beating the market is actually really hard to do.

The truth is that there are millions of people all investing in the same relatively small set of opportunities, and beating the market means you have to have an edge over most of them, including the people who do it for a living. But even investment professionals have trouble. Year after year, the majority of professional investors fail to beat the market. The ones who outperform one year are no more likely than pure chance to outperform again the next year.

The moral of the story here is this: Most investors, both everyday people and professionals, lose to the market. One of the biggest reasons that index investing is so effective is also one of the simplest: Better than past returns. Low costs lead to better returns. Index funds have a simple job: That simplicity keeps costs low, and those low costs are passed on to you in the form of higher returns.

Diversification is one of those fancy investing words, but all it really means it spreading your money out into lots of different types of investments instead of putting all your eggs in just a few baskets.

For example, instead of buying just a few stocks, you can diversify by buying stock in every single company in the US. As the markets move up and down, there will always be people around you consumed with either fear or greed. Index investing makes it relatively easy to stay consistent. This cuts the costs of operating an index fund. Second, index funds have low portfolio turnover.

This reduces the costs of trading and keeps unrealized not-yet-taken gains working for the fund. Third, index funds hold little or no cash. Given the secular rise in stocks over time, this usually pays. Fourth, major market indexes offer exposure to different industries. That is, index funds hold a well-diversified portfolio of stocks—which produces higher profits. Say your grandfather had bought an index fund based on the Dow Jones Industrial Average at the market peak in Under similar circumstances today, indexers would have to wait until the year simply to get back the money they lost.

These numbers reflect what happened in the U. But remember, the Canadian stock market only occasionally deviates from the U. Up until the mids it was easier to wait for share prices to recover. Back then, dividends yielded more than bonds. So you could earn high dividend income. Today dividend yields are higher because interest rates are so low. Now many companies prefer to buy back their shares than to raise their dividends.

With dividend yields lower these days, indexers have less income to offset price losses. Market crashes are not the only setbacks. Consider the period from the end of to the end of Over these 17 years, the gross domestic product the value of all the goods and services produced of the U.