When it comes to investing, there are many options available. One popular strategy and the strategy implemented at Provident Financial Planning is index investing. Index investing involves selecting a portfolio of securities that mimics the performance of an existing index, such as the S&P 500. It has become increasingly popular because of its cost benefits, probability of higher performance than active management strategies, and long-term exponential benefits of the before mentioned attributes. In this blog post, we will discuss why index investing is beneficial and provide an analysis from S&P Global Research that you should consider when making investment decisions.

Cost Benefits

One benefit of index investing is cost savings. Index funds are significantly lower cost than actively managed funds because they require less research and analysis by fund managers. This means you can save money on fees without sacrificing returns or taking on unnecessary risk. In Morningstar’s U.S. Fund Fee Study, the asset weighted average expense ratio for active investors was 0.60% while the asset weighted average expense ratio for index investments was 0.12%, five times lower! Plus, with index funds, you don't have to worry about paying large capital gains taxes each year since the underlying investments don't frequently change (unless there's a major market event).

Probability of Higher Performance

Another benefit of index investing is the probability of higher performance than active management strategies. According to S&P Global Research, “Index funds have outperformed their actively managed counterparts in every asset class over all time periods greater than one year…” This makes sense because when you invest in an actively managed fund, your return is dependent upon the skill level and security picks made by the fund manager. On the other hand, when you invest in an index fund, your return is based on the overall performance of the market or sector that it tracks—which tends to be more reliable over time. In 2021, S&P Dow Jones Indices LLC, a division of S&P Global found that 85% of US Equity Funds underperformed the S&P 500 Index, the 8th consecutive year that greater than 50% of active funds underperformed the index. Less than 6% of all actively managed funds have outperformed the absolute return of the S&P 500 index over the past 20 years from January 2002 through December 2021.

Long-Term Benefits

Finally, another benefit associated with index investing is the long-term exponential benefits of both lower fees and higher performance—especially for those who are looking to maximize their retirement savings or other long-term goals. By choosing a low-cost option like an index fund, investors can minimize their expenses and increase their potential returns over time—all while reducing or eliminating their exposure to unnecessary risk in volatile markets. Additionally, with tax efficiency built into index funds due to their lower turnover rates compared to actively managed funds, investors can keep more money in their pockets when filing taxes each year.

In conclusion, there are numerous advantages associated with index investing that make it appealing for many different types of investors ranging from retail investors to high net worth individuals looking for tax efficient ways to invest their money wisely while still generating solid returns over time. By leveraging cost savings associated with lower expenses compared with actively managed mutual funds, as well as potential tax savings through ETFs offered by Vanguard Products, such as VTI (Vanguard Total Stock Market ETF) and VT (Vanguard Total World Stock Index Fund ETF), individuals can maximize their investments while minimizing risk compared with other investment strategies available today. It should also be noted that although there is no guarantee of outperformance when using an indexed strategy; historically speaking indexed strategies have outpaced active management strategies significantly during periods where markets were volatile or unpredictable giving indexed strategies an edge over traditional active management approaches. With this in mind it is important for any investor considering an indexed approach to do their own research in order to determine if this type of strategy fits into their overall financial plan before making any final decisions about their investments moving forward.

At Provident Financial Planning, our holistic planning process conducted by our in-house CFP®, JD, CPA team allows us to understand all aspects of your financial details. Contact Provident Financial Planning for a free investment portfolio analysis.

Schedule an appointment

Blessings,

Paul S. Michel, CFP®

paul@providentfp.com

‍