Polliesdividend

Teaching my kids – Part 17: Index funds

Another post in my Teaching my kids series

 

As frequent reader of my blog you know that I’m writing some posts to try to financially educate my kids. I know they are still very young (6 and 9) but it is never too early to start. And they can read these blog posts later on in life 😉 (This is probably the case, because they don’t speak or read English very well at this moment – You got to love an understatement!).

This is another blog post to keep the “snowball of knowledge” rolling.

I think when you educate kids about money, they will benefit from it for the rest of their lives. Or as the saying goes: “What is learned in the cradle is carried to the tomb”. And to educate your kid is your responsibility as a parent.

This blog post is a post for my kids when they are a little bit older. I did not talk to my kids about this subject (yet).

 

www.polliesdividend.com

 

Last week I had a little conversation on Twitter with a fellow Dutch DGI. He asked if trackers could be included on my list of Dividend Zombies. I had to amid that my knowledge about trackers wasn’t that great.

I know that I started this series to financial educate my kids, but this time the research I did for this post, also educated me 😉 So this post works both ways.

 

Investing possibilities

When you want to start investing, you have a lot of possibilities to invest. First you can buy an individual stock, for instance Google, Apple or Coca Cola. In my post What is a stock? I explained to my kids what a stock actual is.

You can also buy bonds. In my post What is a bond? I explained this investing vehicle. Another option is to buy a mutual fund. A mutual fund invests the money from various investors. This money is used to buy all kind of investments. With a mutual fund you spread the risks of your investment. Most mutual funds are actively managed.

This means that the manager of the mutual fund chooses the fund’s investments using a combination of in-depth research, market forecasting, experience, and expertise. This results in higher management fees and costs for this mutual fund. And higher costs means lower results for you as investor (these fees and costs are charged to you as a buyer of this mutual fund). While the objective of the fund is to beat both its comparable market benchmark and its peer-group averages, it can also underperform (due to higher costs)—resulting in losses for the fund and its investors

 

Passive investing

An other possibility is to invest your money in an index fund (passive investing). An index fund follows an index (for example the AEX or DJ). If the index goes up, the index fund will increase by the same amount. Because the fund manager doesn’t have to do a lot of research (he/she just has to follow the index) an index fund has lower costs.

 

What is an index fund?

An index fund (also called ‘tracker’) is an investment fund that strives to achieve the same return and risk as a certain stock market index rather than trying to beat it. Most index funds do this by simulating the index. They invest in the same stocks or bonds as those in the index, in the same proportion as they are included in the index. Because an index fund ‘passively’ follows the index, it does not require expensive analysts and fund managers and carries out much less expensive transactions. As a result, the costs of index funds are much lower than that of actively managed investment funds and other asset managers. I read on the Internet that on average the costs are two to three times lower. And because of the much lower costs and the fact that stock prices are not or barely predictable, index funds perform better than the vast majority of actively managed investment funds and other asset managers.

 

Lets take a closer look

The famous Jack Bogle launched the first index fund on August 31, 1976. With his company Vanguard, he invented the Vanguard 500 Index, which offers its investors exposure to the 500 largest U.S. companies (S&P 500 Index).

The S&P 500 Index is comprised of the 500 largest and most widely held stocks on the New York Stock Exchange. In this index there are a lot of well-known companies, some really big names we all know or products we all use. Lets take a look of the list of its top 10 companies:

  • Apple
  • Microsoft
  • Alphabet (Google)
  • Amazon
  • Facebook
  • Berkshire Hathaway (Warren Buffett’s conglomerate)
  • JPMorgan Chase & Co.
  • Johnson & Johnson
  • Exxon Mobil
  • Bank of America

 

Thus when you buy I share of the Vanguard 500 Index fund, that share gives you exposure to all of the companies within the S&P 500! So you don’t have to buy dozens and dozens of individual stocks by yourself to obtain diversification. Buying shares of the 500 Index Fund will take care of all of the diversification for you.

 

Finally

This is my seventeenth blog post about teaching my kids. I hope my kids at the age of say 18, have all the financial knowledge I’m having right now. This would be a huge advantage for them! And that’s why I started these blog post series.

What do you tell your kids about money and investing? Do you own Index funds?

I like to hear from you!

Help me get the “snowball of knowledge” rolling and share this post.

Cheers,

Pollie

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2 thoughts on “Teaching my kids – Part 17: Index funds

  1. DutchIndependence

    I have been researching for my sister where to put her money which she has for her baby, I came to the conclusion I’d put my money 50/50 in Vanguard ETF’s between the S&P500 & a Europe index. All of the diversification, none of the hassle. Great piece Pollie!

    DI

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