I Will Teach You To Be Rich: No guilt, no excuses - just a 6-week programme that works

by Ramit Sethi

Two per cent doesn’t sound like much until you compare it with the alternative: “passive management”. This is how index funds (a cousin of mutual funds) are run. These funds work by replacing portfolio managers with computers. The computers don’t attempt to find the hottest stock. They simply and methodically pick the same stocks that an index holds – for example, the five hundred stocks in the S&P 500 – in an attempt to match the market. (An index is a way to measure part of the stock market. For example, the NASDAQ index represents certain technology stocks, while the S&P 500 represents five hundred large US stocks. There are international indexes and even retail indexes.) Most index funds stay close to the market (or to the segment of the market they represent). Just as the stock market may fall 10% one year and gain 18% the next year, index funds will rise and fall with the indexes they track. The big difference is in fees. Index funds have lower fees than mutual funds, because there’s no expensive staff to pay. Vanguard’s S&P 500 index fund, for example, has an expense ratio of 0.14%. Remember, there are all kinds of index funds. International funds, healthcare funds, small-cap funds. There are even funds that match the overall US stock market, which means if the market goes down, these index funds will also go down. But over the long term, the overall stock market has consistently returned about 8% after inflation.