Since then, a zillion index funds have come out to track big companies, small companies, medium companies, all companies, etc., but they share some really nice features for investors:
- Good return on investment: An index fund matching the S&P 500 beats up to 90% of actively-managed funds in the long-term.
- Low expenses: Expensive funds don't yield any better performance than cheap ones, so you always want to minimize expenses. That's why you should never buy a loaded fund (where you pay up front to buy a fund), and you want to have a low expense ratio. Index funds don't require much management, and don't buy and sell shares very much, so there is very low overhead.
- Diversification: Unless you buy an index fund which specializes in a certain industry, you are getting a broad swath of companies. If one industry tanks (like the Internet, for example), you take a hit but you haven't lost everything. See the Disneyland entry of the investment club for more details on what I mean. A broad-based index fund like Vanguard's Index 500 is like the Big Thunder Mountain Railroad: some ups and downs, but pretty tame over all.
- Taxes: There are three basic types of investment accounts: tax free (e.g. Roth IRA), where you never have to pay taxes on what your investments earn; tax deferred (e.g. standard IRA), where you don't have to pay taxes until you take your money out of your account; and taxable, where you have to pay each year on what you earn in dividends and capital gains. For the first two types of accounts, it doesn't really matter how tax efficient your investments are because the money you would pay each year in taxes gets reinvested regardless. If you have a taxable account, however, you have to pay capital gains when a mutual fund sells stocks for more than it paid for them. What you pay in taxes you can't keep investing. Index funds work almost like a tax deferred account because they buy and sell very little, so the money you would have payed in taxes this year is still in your investment.
- Bank of America
- Johnson & Johnson
- General Electric
The other alternative is socially responsible investing. The definition of socially responsible can vary greatly, but any socially responsible investment will probably rule out the worst offenders. Socially responsible mutual funds have the same problems as regular mutual funds: actively managed funds have high expenses, which lower your returns. There is such a thing as a socially responsible index fund, however. Vanguard has a fund (VCSIX) which tracks something called the Calvert Social Index (CSI). If you compare the social index fund with the plain one, you find some key differences. The top ten for the CSI fund excludes ExxonMobil, GE, Citigroup, and Wal-Mart! Of course, the return on your investment has been lower for the socially responsible fund, so there is a tradeoff. Here is an article I googled up which discusses social index funds. Just be sure to check the expense ratio before you buy, since some index funds have higher expenses than others.
DISCLAIMER: I don't receive any money for anything I mention, although I do own VFINX. Remember, this advice is worth what you paid for it - get lots of opinions to help you develop your own! In particular, I offer no advice as to whether now is a good time to purchase an index fund or anything else, since I don't really know. I'm in it for the long-term.