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I’ve owned stock-index funds for more than three decades—and that’s made a huge difference in my financial life. What if index funds didn’t exist? I can think of five key ways my financial life would be worse:
I’d allocate less to stocks. With broad market stock-index funds, I know I’ll get whatever the market delivers. If the alternative was actively managed funds or individual stocks, there would be far more uncertainty—and I’m not sure I’d have the confidence to allocate as big a portion of my portfolio to stocks. Result: My long-run returns would have been lower.
I’d spend more time on my portfolio. Picking a few low-cost, broadly diversified stock-index funds is a cinch. By contrast, trying to identify winning individual stocks and actively managed funds is a ton of work—and history tells us it’s a loser’s game.
My financial life would be more complicated. Because the performance of individual stocks and active funds is so uncertain, I’d want to hedge my bets—and that would mean owning far more investments.
I’d pay more in taxes each year. Because of their low portfolio turnover, broad stock-market index funds tend to make minimal taxable distributions each year, especially if you buy exchange-traded index funds. Buying and holding individual stocks can also be a tax-efficient strategy. What about actively managed stock funds? They’re notorious for making large taxable distributions each year, which is why these funds are best held in a retirement account.
I’d almost certainly pocket lower long-run returns. Heaps of data tell us that the vast majority of actively managed stock funds lag behind the market averages over the long haul, thanks to their fund expenses and trading costs. What about individual stocks? If folks are careful, the costs can be minimal.
Still, most investors who favor individual stocks are likely to lag behind the market averages, thanks to a phenomenon known as skewness. In any given year, the market averages are skewed higher by a minority of stocks with huge gains, so most stocks—and their owners—end up with below-average returns. What if you happen to own the year’s big winners? Count yourself among the lucky few.
I am totally committed to index funds, for the reasons you articulate. I might get tempted by one of those “indexes with a twist”, but not as one of my backbone investments. It has been easy to be an index investor the last few decades. Even big drops in the market have not lasted long. The real test may come if we suffer a prolonged downturn, with a gradual decline that endures. How we will react then? Do you jump into more bonds? Do you start to look for stocks and sectors where your declines are less steep? (I actually think I would stay the course and not lose a minute of sleep, since I feel I have been playing with house money now for many years.)
Totally agree, Jonathan. Thank you!
Ran a hypothetical using a value fund we have had for decades and a 4% + 3% annual withdrawal. Compared to S&P 500 Index–began with $300,000 in year 2000 through 2025–we had numerous bear markets like the one in 2000 and who can forget 2008 as well as covid crushing us with a 33% decline followed by 2024 when stocks and bonds struggled.
As of 03/31/2025 withdrawal was almost $444,000 from our fund, while the amount from the index was $431,000+ as it ran out of $ in January of 2024. Our fund at end of 1st quarter this year had a value of almost $744,000.
How many people use the index as the equity portion of their withdrawal portfolio? I always hear it described as a wealth builder but to me that is half the game.
Which value fund did you use for comparison? Was it a large-cap value fund? Was it actively managed?
The years 2000 – 2010 are known as the “lost decade” for the S&P 500, which lost an average of about 9% each year. But other asset classes like small-cap value and REITs did fairly well.
What you have demonstrated is that during your chosen time period, your value fund outperformed the S&P 500. But choose a different time period and the result would likely differ.
I believe Jonathan’s arguments are still valid.
yes, large cap value–yes, different time different results–but for many of us retired folks the year 2000 is, in my opinion, ideal, as is any period where you have major bear markets that make withdrawals very tricky–I want to see results for time periods that encompass the worst not the best.
We are constantly told about beginning withdrawals in a down market cycle–well, this 25-year period is just that and is what constitutes a retirement period for maybe at least one spouse.
So far I see in my readings here and other places accumulation is always the go to when index is discussed–when I watch NBA finals I see a game played on both sides of the court.
In my humble opinion when setting up withdrawals from equity funds, volatility plays a major role. Ed Marsh below echoes my thoughts about spare time and complicated. In this house it has been very simple–4+3 and leave it alone. No green eye shades, no hours picking one index over another, no buckets –no nothing, don’t even think about it.
Now we have been investing for over 55-years using a few good funds and leaving things alone–adding monthly for those 55-years up to today. Buffett has the right idea when it comes to nervous energy and he is big on indexing to gain wealth–but what about withdrawal?
Blue chip stocks–managed fund asset (in my case)–an emphasis on dividends which sure helps to moderate volatility. Works for me.
The S&P 500 funds are hardly the only index funds. Personally, I favor total market plus international.
thanks–I think the question is how well, whatever indexes used, did they (it) perform from 2000 to 2024 or 03/31/25 during withdrawal–all I hear about is accumulation.
For a decade or more all the action has been in U.S. markets so an international index of equities most like trailed somewhat significantly until maybe this year.
At some time one usually begins withdrawing and if so is the equity portion indexed and if so what were the results in a 25-year period (2000-2024) that had a number of major bear markets. If one decides to have a 60/40 portfolio are the equity vehicles indexes such as those used during accumulation?
I’ve done some numbers for the most recent 10 years regarding the draw-down of a 60/40 portfolio. No guarantees here! Annual dividend yield over that period was 1.52% to 2.35%. The portfolio gained on average 8.45% per year adjusted for inflation before taking withdrawals. It would be capable of supporting a 4% annual withdrawal. After the 10-year period the portfolio value was about 57% larger than at the beginning of withdrawals. However, that assumes a drawdown each year from both stocks and bonds, which would not be my personal approach. I used Vanguard ETFs. Over the 10 year period inflation would have decreased purchasing power to about 74%. I’ve read that buying into a 40/60 portfolio on any given trading day from about 2000-2020 would have returned 9.4% over the following year, on average. That’s a better return than from 2015-2025. I realize my numbers don’t perfectly reflect reality.
That’s an interesting question, but it isn’t answered by using only one fund of each type, especially when one is the S&P 500, and total market funds have become popular.
thanks–but my question is simple–how does indexing work on the withdrawal phase–I used he S&P 500 which in 2000 was by far the index of choice–how would the total market index have done–
it seems to me that everyone knows the accumulation situation but what about phase 2 for most folks? When you have numerous bear markets beginning in 2000 and you could easily live another 25-years how did whatever index you use do?
do folks use index funds as part of their withdrawal portfolio?
I suspect that almost every retiree who frequents this site owns stock-index funds. But they also hold cash investments and bond funds, and that’s where they turn for spending money when the stock market drops sharply.
Al Lindquist
Interesting–I would be curious to see how bonds and cash provided income from 2000 to ’24. Interest rates plummeted during many years of that period. Remember the mortgage rates of 2.5%-3.5%?
Looks to me that spending money would be extracted from interest and maybe principal.
Indexing sounds good on the way up but distribution makes me wonder.
I agree. My spouse’s portfolio has Vanguard Target Date funds since 2004. These include total US market, international stocks, US bonds, Ex-US bonds and TIPS fund. It has done well.
sounds good–was there a withdrawal program and if so how well did it work?
G won’t have to deal with RMDs for another 4 years. If I’m no longer her, she’ll probably just sell shares each year. As she approaches RMD age she can sell the Target Funds and replace with the component ETFs. That would allow her more flexibility in deciding what to sell each year, but I doubt that she’ll do that.
I’d add a sixth: My financial life would be more stressful.
I would worry if I bought the right shares or funds, if I paid a smart price, if I should sell now or later, if I sold too soon, and on and on.
This is probably my #1 takeaway. Reduce complication, make execution as easy as possible, eliminate confusion to make action easier and faster.
Wish I’d figured this out 30 years ago, but better late than never.
“Spend more time” and “complicated” is not a recipe for happiness for me. But I know some folks thrive on the effort they put forth–until they can’t.
Decades ago my dad gave me some shares of a particular stock. I set a sell price in my mind and was anxious every day until the stock reached that price. I was so relieved when index funds became available. I’ve been a buy-and-hold investor in total-market passively managed index funds ever since. Eternally grateful to Jack Bogle.
I have a slightly different perspective. When I began investing in the 1990s I purchased mutual funds, later there were Exchange Traded Funds (EFTs).
Today, I don’t own indexes, per se. I prefer to own companies I like; their products, services and management. Conversely, there are companies I don’t want to own. Indexing makes it difficult to cull the herd.
Why am I particular and avoid certain companies? Because I disagree with the manufacturing and business ethos, or the products. These companies sometimes occupy a significant slot in the indexes. For example, I do avoid owning gambling, tobacco or whiskey and beer/spirit stocks. I also have issues with some of the drug and insurance companies. There are others I prefer not to own.
I do own stocks in companies I like, and I am financially rewarded for this.
There are methods to achieve my goals with low fees. Instead of indexes I continue to own certain lower cost mutual funds and ETFs including sector funds. I admit this approach is not suitable for everyone. My personal approach may have depressed some of my returns.
It is difficult to escape certain stock ownership completely, but it can be reduced. For example, my portfolio is 0.27% Apple, 0.16% MercadoLibre, 0% Nike and 0% MGM Resorts.
It is certainly far easier to own the indexes and ignore what they contain.
To compare approaches, my spouse’s portfolio includes 2020 and 2025 Vanguard Target Date Funds. They are about 25% of her portfolio. She also owns several other ETFs. Her percentage of “aggressive growth” and “speculative growth” is higher than that of my portfolio. That’s what happens when certain stocks dominate an index.
On the plus side, I think the time spent increasing my wealth has been worth it. I’m an avid reader, preferring tech and business and production practices as well as the sciences, etc. I’ve studied many businesses and sectors. Some of this was to enable me to better run my company. Some was necessary because, particularly in the tech world there has been a lot of vapor ware and underperformance (forget about the marketing and stock performance which are not always good indicators).
I spent my career in the wealth management biz and came to a similar conclusion by the time I retired. Despite all of our professional certs and years of experience, our performance never quite matched our aspirations. So, what did we really do to earn our 1.5% annual fee? We served as a clearing house for almost any sort of financial question, we helped clients with their estate planning and the management of family dramas, but most importantly, we helped clients avoid making as many foolish investment and financial decisions as possible. In the end, I think we earned our fees, but not necessarily for our investment management.
Not many people have the ability to assess their careers as candidly as you, Mr. Duck. I see advisors can really help their clients with things like getting the right life insurance, use of retirement planning tools like IRAs, 401Ks, SEP IRAs, taxation, etc., and help with college planning. Many people don’t have the time or inclination to deal with all that complexity, and just by preventing a few big mistakes an advisor can more than pay for themselves. By the way, I’m a native of Eugene, OR. Go Ducks!
My spouse’s 403b was professionally managed. While the employer made no contribution, G was required to pick from a list of firms. For a few years Vanguard was included but then the finance manager for the employer struck them from the list. So, she had two 403b’s at that point. G picked a fund manager who provided a list of actively managed funds. I assisted her. Her Vanguard portfolio had Target Date Funds. The fees were a drag on the second actively managed portfolio. I produced charts comparing the performance of the two 403b’s; the Target Date Funds did better. I told G to reconcile this with the quality of advice she was given. After retirement she rolled that 403b into a self-directed IRA.
Thanks Jonathan. I was also a part of an investment club for a number of years. I enjoyed the experience, especially learning how funds work, and doing the accounting. But I learned I was a lousy stock picker, and didn’t particularly enjoy it. But I learned the value of saving, investing in index funds, and paying attention the other equally important areas of financial planning – cash flow, taxes, estates, insurance, …
Couldn’t agree more. I was, briefly, a member of an investment club, and I found the research extremely boring.
Either through ignorance or error I was late to index investing. No doubt my IRA balance would be larger if I’d abandoned managed funds earlier. I do take solace in the fact I at least saved and invested, even if my choices weren’t optimal.
Hey Jonathan, thanks for pointing out something I had not thought of in all my singing of Jack Bogle’s praises, how much time he has saved me managing my portfolio. For decades I pointed out to people all the billions of dollars he has saved investors the world over due to the low investing costs resulting from index funds’ structure. However you just enlighten me to the fact that without index funds I would definitely be paying AUM costs as well, because there is no way I would feel qualified, have the time, nor the patience to pick individual stocks. I can’t even imagine the anxiety.
I used to spend hours trying to analyze and allocate managed funds, and rarely did I win. Now I spend that time responding to posts on HumbleDollar.
A very judicious use of time. 🙂