What is an Index Fund? And, Why Are They Good for Your Retirement?

What is an index fund? Well, to start, it’s the type of investment recommended by the most famous investor in the world. On December 19, 2007, Warren Buffett—chairman of Berkshire Hathaway and one of the world’s wealthiest investors—made a bold bet with hedge fund manager Ted Seides: that a low-cost S&P 500 index fund would outperform a portfolio of actively managed hedge funds over the next ten years. Buffett didn’t just win the bet—he made a point. (For the full breakdown, see his 2017 annual letter.)

Buffett’s lesson for everyday investors is clear: most people pay too much for too little. “American investors pay staggering sums annually to advisors,” he wrote, “often incurring several layers of consequential costs without any clear benefit. In the aggregate, do these investors get their money’s worth? Indeed, again in the aggregate, do investors get anything for their outlays?” His answer: no.

Managed Funds Have High Costs and Returns that Aren’t Better

Most people who work with a traditional advisor pay what’s called an assets under management (AUM) fee—typically around 1% of the value of their portfolio each year. That may sound small, but it can cost tens or even hundreds of thousands of dollars over time. Worse yet, you’re not necessarily getting better returns in exchange for that cost.

You’re paying someone to actively manage your investments, and they get paid whether or not your portfolio performs. In reality, broad-based index funds consistently outperform most actively managed investments. Buffett’s famous bet made that clear: over a decade, a low-cost S&P 500 index fund beat a carefully selected group of hedge funds weighed down by fees. Check out this analysis.

Here’s the math: a 1% annual fee on a $500,000 portfolio can cost you (conservatively) over $140,000 in lost returns over 20 years. That’s money coming out of your future—not just your portfolio.

Want to see for yourself? Use the Boldin Retirement Planner to model a 1% smaller return on your portfolio.

Or, dive deeper into fees and expenses on mutual funds and ETFs.

A Better Alternative

Fortunately, the rise of low-cost index funds (like ETFs) and the shift toward zero-commission trading at major brokerages have made it easier than ever to invest in the global economy with minimal cost—no hedge fund or high-priced manager required.

And if you do want professional guidance, fee-only advisors are a more transparent and cost-effective alternative. They charge a flat or hourly rate and are focused on helping you build a plan, not selling you products. A good fee-only advisor can help you design the right asset allocation, suggest low-cost index funds, and teach you how to confidently execute your strategy—all without draining your returns in the process.

Boldin Advisors: Boldin Advisors offers fee-only services. Book a free discovery session to learn more.

What Is an Index Fund?

An index fund is a type of investment that aims to mirror the performance of a specific market index—like the S&P 500—instead of trying to beat it. Unlike actively managed funds, index funds don’t rely on expensive research or stock-picking strategies. They follow a fixed formula, which keeps costs low and results more predictable.

The first index fund was created in 1975 by Vanguard founder Jack Bogle, and it was called “Bogle’s folly.” At the time, investing was expensive; it required a human broker, and the idea was to create greater returns than you could get from risk-free investments like bonds.

Folly becomes Foresight

Turns out, index funds were game changers because they focused on matching the return of an entire class of investments, like the stock returns of the companies in the S&P 500, instead of trying to beat the market the way actively managed mutual funds do. But to get there, they had to overcome the misperception that investment professionals can get better returns picking winners than if they just invested in all stocks equally. 

Bogle saw a difference between investing and speculating. Investing seeks to preserve capital at a lower rate over a longer time horizon, while speculating seeks to find advantages for traders in the short term at a higher rate of return with a greater risk to capital. Everyone who is saving for retirement should be investing and not speculating. But active fund managers are paid to speculate on market moves and the performance of individual stocks.

Today, index funds can be as broad as a “total market” index or can cover a relatively small set of assets, like emerging markets in Latin America. But the point is you invest in an index, not the wisdom of a manager. 

Index funds are low cost diversification

If you’re looking for a simple, low-cost way to grow your money for retirement, index funds are one of the smartest tools available. They offer instant diversification, low fees, and long-term returns that often outperform actively managed funds.

Choosing the Right Index Fund: What to Look For

When evaluating index funds, two things matter most:
1. What does the index track?
2. How much does it cost to own (expense ratio)?

Popular Types of Indexes

You have a lot of choices when it comes to choosing an index fund. Most index funds track stocks, but there are also options that focus on bonds, real estate, commodities, or even cryptocurrencies. Some of the most well-known stock market indexes include:

• S&P 500 – Tracks 500 of the largest publicly traded U.S. companies. It’s one of the most popular benchmarks for investors seeking exposure to the U.S. economy.
• Dow Jones Industrial Average – Tracks 30 large U.S. companies. It’s historically important but offers less diversification than the S&P 500.
• Russell 3000 – Covers 3,000 U.S. companies, making it a great snapshot of the total U.S. stock market.
• Small-Cap Indexes – Focus on smaller, high-growth companies, which can offer higher potential returns (and risk).
• International and Global Indexes – Track companies outside the U.S. or across the entire globe. A good example is the Vanguard Total International Stock Index Fund ETF (VXUS), which gives investors access to thousands of non-U.S. companies.

One of the greatest strengths of index funds is instant diversification. Buying just one fund—like an S&P 500 or global stock index—can give you exposure to hundreds or even thousands of companies, helping spread risk across industries, sectors, and geographies.

Beyond stock indexes, you’ll also find index funds that track bond markets, commodities like gold, or even cryptocurrencies, offering even more options for diversification.

Expense Ratios: The Hidden Cost That Matters

All investment funds come with costs, but index funds are usually much cheaper than actively managed funds. The expense ratio represents the annual fee you pay to own the fund, expressed as a percentage of your total investment. For example, a 0.10% expense ratio means you’ll pay $10 per year for every $10,000 invested.

That may sound minor, but the difference adds up—especially over decades. Many actively managed funds charge around 1% annually, which could cost you over $140,000 in lost returns on a $500,000 portfolio over 20 years.

Index funds avoid these high fees because they simply follow a predefined list of investments, with very little turnover. That also makes them more tax-efficient—especially ETFs, which are designed to minimize capital gains distributions through a unique in-kind exchange process.

According to Morningstar, the average expense ratio for all mutual funds and ETFs is about 0.45%, but many index funds charge far less. For example, VXUS charges just 0.08%—a fraction of what most actively managed funds cost.

Why Index Funds Work: The Advantages

Index fund investing has become the gold standard for long-term retirement planning—for good reason.

• Diversification: You get exposure to hundreds or thousands of companies in a single fund. As John Bogle said: “Don’t look for the needle in the haystack. Just buy the haystack.”
• Low Cost: No expensive managers or research teams to pay. Index funds follow a simple, automated strategy.
• Proven Performance: Over long time horizons, index funds routinely outperform most actively managed mutual funds and even hedge funds.
• Simplicity: You don’t need to constantly monitor or rebalance your investments. Buy, hold, and let the market do the work.
• Tax Efficiency – Low turnover means fewer taxable events, which helps maximize after-tax returns—especially with ETFs.
• Behaviorally Helpful – Because they remove the need to chase performance or time the market, index funds reduce costly investor mistakes.

Are There Downsides to Index Funds?

While index funds are smart for most investors, they’re not risk-free. When the market drops, index funds drop with it. If you’re retired or planning to withdraw money soon, you could be forced to sell during a downturn.

That’s why it’s smart to diversify beyond just stock-based index funds, especially for near-term needs. A retirement portfolio might include bond index funds or cash reserves to help smooth the ride.

What Return Can You Expect?

Historically, the S&P 500 has returned about 8% annually, which is what Warren Buffett used in his famous bet against hedge funds. But there are caveats:

1. Inflation matters. If the market returns 8% and inflation is 5%, your real return is only 3%.
2. It only works if you stay invested. Trying to time the market or switch between funds undermines the benefits of indexing.
3. Focus matters. If you invest in a narrow or declining sector (like fossil fuels or outdated technology), long-term performance may suffer, even if it’s an index.

That’s why broad, low-cost index funds are usually a great bet for most retirement investors.

Why Boldin Believes in the Indexing Mindset

At Boldin, we’re inspired by the same values that make index funds so powerful: simplicity, transparency, and efficiency. Just like index investing, our planning tools are designed to give you control without the noise—and at a cost that doesn’t eat into your future.

If index funds are the smartest way to invest, we think Boldin is the smartest way to plan.

Start your plan today.

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