You'll learn why it's a smart choice for long-term growth and how it can help you achieve your investment goals.
Perfect for beginners or those looking to simplify their investment strategy.
Did you know that over 92% of actively managed funds fail to beat the index over a 15-year period? On average, they cost more and deliver lower returns for investors.
This surprising fact has led many to turn to index investing. Not only individuals, but even entire nations have adopted this investment strategy as part of their pension systems.
We will examine the Swedish pension system and compare various types of indexes to provide a better understanding of how index investing works.
If you're interested in learning more about the creator of the first index fund, you can find additional information over here.
What is an index fund?
An index fund is a type of investment vehicle that aims to replicate the performance of a particular market index, such as the S&P 500, NASDAQ or the world.
These funds are managed passively, meaning they simply aim to track the performance of the index they are based on, rather than attempting to beat the market through stock picking or other active strategies.
Index funds are a popular choice for investors who want to gain broad market exposure and diversify their portfolios without the need for constant monitoring and management.
They are also known for their low costs, as they don't require a team of analysts and portfolio managers constantly researching and buying, and selling stocks.
How The Swedish Pension System Works
I want to discuss how an entire nation's investments are made for its citizens and provide insight into how you can invest.
For example, if a Swedish citizen logs into minpension.se, they can see exactly how their pension savings are invested.
All of this is invested into a fund called AP7 Såfa, which is 100% invested in a global index.
After the age of 56, a portion of it is invested in interest-bearing investments to add safety, as they are less volatile.
However, the interest rates are not very favorable over the long run.
If we instead look at a global index fund, they have actually outperformed the index due to the leverage in their investments.
We will dig deeper to understand why they chose this particular index.
While this article focuses deeper on one country's investments, it is likely that many developed nations have similar strategies, as index investing has proven to be very effective
Historical Index Returns
Now, the question is, how has the index performed historically? Are there any indexes that have performed better or worse?
With our investing time machine, you can go back in time and see how the S&P 500 has performed in the past.
You can also see what your money would be worth if you had invested in the past until today, or at any other point in time.
We developed this tool to illustrate how index investing works and to dispel the fears associated with not wanting to invest.
With this tool, you can see your potential returns if you invested at the worst/best time, at the average price, or at the start of the year.
But the S&P 500 is only one index and while the US economy is a significant portion of the world economy.
When we compare the S&P 500 to a global index, we can see that it may have performed slightly better.
If we take a look at another country's index, such as Japan, which has been facing a declining birth rate, we can see that their index has not yet recovered since 1990. It's concerning to see that over 30 years, there has been no growth.
Automatic Risk Management
When considering different indexes, it's important to take into account factors such as demographic trends and economic conditions.
For example, Japan's declining birth rate has had a negative impact on its index since 1990, and it has yet to fully recover.
However, it's important to remember that no investment is without risk, and diversification is a key risk management strategy.
In comparison, the S&P 500, which comprises the largest companies in America, has historically outperformed the world index.
Indexing works because it utilizes one of the most basic risk management strategies, diversification.
However, no investments are without risk. Even if you had diversified into Japan's index 30 years ago, you would not have seen any returns.
On the other hand, if you had diversified into the S&P 500 (the biggest companies in America), you would have outperformed the world index.
This illustrates the pros and cons of diversification. It protects against risks, but it can also limit the upside.
The big question is, how can you know which index will perform the best without the benefit of hindsight?
Past performance is not necessarily indicative of future performance. While it may be useful to compare past performance to make informed decisions, it is important to remember that no one can accurately predict the future.
Investing is inherently speculative, and it is important to consider all factors when making investment decisions.
Common misconceptions about index investing
- Index investing is only for long-term investors: One common misconception is that index investing is only for those who are able to hold their investments for a long period of time. However, index investing can be beneficial for investors of all time horizons, as it provides broad market exposure and can help to diversify a portfolio.
- Index investing is too risky: Some people believe that index investing is riskier than actively managing a portfolio, but in reality, index funds tend to be less volatile and have lower management fees than actively managed funds.
- Index funds only track the S&P 500: Another misconception is that index funds only track the S&P 500, when in fact, there are index funds that track a wide variety of market segments and asset classes, such as international markets, emerging markets, small-cap stocks, and bonds.
- Index funds don't beat the market: Some people believe that index funds cannot beat the market, but in reality, index funds have been shown to perform as well or better than actively managed funds over the long-term.
- Index funds are expensive: It's a common belief that index funds are more expensive than actively managed funds, but in reality, index funds tend to have lower management fees than actively managed funds.
- Index funds are not tax efficient: Some investors believe that index funds are not tax efficient, but in reality, index funds are generally more tax efficient than actively managed funds because they have lower turnover and less capital gains distributions.
It is important to note that, like any investment strategy, index investing also have its own set of pros and cons.
And I understand that it may be difficult to accept that passive investing is the best option.
However, it's important to realize that you're not actually doing nothing. Instead, you're earning returns simply by investing in the global economy.
Even if you're still not convinced about indexing, it's essential to continue investing in some capacity.
Take a deeper dive into our compound interest calculator to fully understand the potential benefits of investing.
In this article, we explored the Swedish pension system and its investment in the global index through AP7 Såfa.
This fund utilizes a small amount of leverage, which has helped it outperform the global index.
We also examined the performance of different indexes, including the S&P 500 and Japan's index.
We noted that although the S&P 500 has outperformed the world index, Japan's index has not recovered since the 1990s.
Diversification is a crucial risk management strategy in investing, and index investing is one way to achieve it.
Index investing allows for broad market exposure and protects against risks, but it also comes with limitations as it does not guarantee the same returns as in the best-performing stocks.
But instead of getting the entire return, you only get a portion of it. And the same goes with any losers.
In conclusion, index investing provides a simple and efficient way to invest in the market and manage risk through diversification.
It is important to keep in mind that past performance does not guarantee future results and that investing always carries some level of risk.
However, the potential benefits of investing, such as compounding interest, can be significant over time.
Want to ensure the safety of your investments? Or ensure greater privacy? Read more about it here.