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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?