F.I.R.E. Essentials: Low Cost Index Fund Investing

Intro to Low Cost Index Fund Investing

index fund


Have you heard of low cost index fund investing? Investing your money in the stock market doesn’t have to be difficult or stressful and you certainly don’t have to spend dozens of hours researching to succeed for the long-term.

In fact, I would argue that the most effective long-term wealth building strategy for the stock market also happens to be the simplest. Our investing advice is this:

Buy an ultra-low-cost diversified index fund and continue to purchases new shares automatically on a set time schedule. We suggest the Total US Stock Market Index Fund (VTSAX) or S&P 500 Index Fund from Vanguard, but there are comparable funds at Fidelity and Schwab that accomplish the same goals.

Don’t check how the market is doing, don’t get skittish and sell when the market drops, just keep pumping money in there week after week (Vanguard lets you setup an automatic investment on a weekly, bi-weekly or monthly basis, so whatever best fits your schedule).

You’re going to wake up one day as an extraordinarily rich person and you’ll have experienced much less stress along the way than nearly every other investor!

How Does Warren Feel about Low Cost Index Fund Investing

index fund warren buffett

Don’t believe us? Here is Warren Buffett – the greatest investor the world has ever known – from his 2013 Berkshire Hathaway Shareholder Letter:

“The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.”

“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will…My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors who employ high-fee managers.”

If that advice is good enough for Warren Buffett’s wife and children and their billions of dollars, you can bet it’s solid for your family too!

Our favorite resource to learn more about low cost index fund investing is the Stock Series at JLCollinsNH.com. This has become THE resource for the financial independence community and it is essential reading.

What is an index fund?

Investopedia defines an index fund as, “An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.”

In the case of the S&P 500, you’re buying a tiny piece of all 500 companies in the S&P 500 index. So many people miss this fundamental point: You are not buying a piece of paper when you buy a stock or mutual fund, you are buying an ownership percentage of an actual company!

So instead of short-term trading and getting lucky on stock price fluctuations, we are going for long-term wealth building by buying a piece of either the 500 biggest publicly traded companies in the US (S&P 500 Index) or essentially every publicly traded company in the US when you buy a Total Stock Market Index Fund (at publication of this article, the Vanguard Total Stock Market Index Fund has nearly 3,600 companies in the index).

The Impact of Fees on Your Investment

Over the long-term, nearly no investor can outperform the market (and don’t get us started on timing the market, which is even harder). If you take that as a given, then the fees are the single most important factor to building your wealth.

Here’s a visual representation of the impact of fees on your investment:

Scenario 1 : Low Cost Index Fund all the way

We’re assuming someone starts with $100,000 and plans to invest for 40 years while adding $0 future dollars. We’re assuming an 8% gross annual stock market return, however if you invest in VTSAX the expense ratio is 0.05 percent annually, so it reduces your annual return to 7.95%. When compounded over 40 years (thanks to this investment calculator for the math), you end up with an astounding $2,132,582.

Low Cost Index Fund - best case scenario

Scenario 2 : Mutual Fund instead of an Index Fund

However, let’s say instead of VTSAX you decided to invest in a mutual fund with a 1% expense ratio, so your net annual return is now 7%. That 1% fee didn’t sound like much upfront, but instead of over $2.1 million in VTSAX, you now have only $1,497,445. You’ve lost nearly a third of your investment just by investing in an actively managed (high fee) mutual fund!
Go with the low cost index fund

Scenario 3 : Financial Advisor + Mutual Fund instead of an Index Fund

Now, just for fun let’s say you doubled down and hired a “helper” (thanks Mr. Buffett for that great term!) also known as a financial advisor and they charged you 1% plus invested you in a mutual fund with a 1% fee. So your net return is now only 6%. At the end of 40 years you only have $1,028,571. You now lost half your potential return for absolutely nothing! I can almost guarantee that helper’s “brilliance” wouldn’t have brought you any increased returns over the long-term and the drag of their expensive fees just kills your return.
Go with the index fund


Recommended Tools/Resources

Personal Capital this is our preferred tool for tracking our investments and its free to set up

Related Podcast Episodes

Investment Fees are Evil

Millionaire Educator





13 Replies to “F.I.R.E. Essentials: Low Cost Index Fund Investing”

  1. Jonathan & Brad – Love the show! As you guys have mentioned, even if I can’t implement all the ideas that are presented, grab on to some nuggets and apply them. I’ve done that. My wife and I are currently on our second Chase Sapphire – sitting on approximately 110k Ultimate Reward points. Brad, you opened my eyes to a new way our money can be working for us. The Millionaire Educator has us tax planning for 2017 – with two children and strategic savings, that 10% bracket is certainly within our grasps. Here’s my issue: I want to move our Roths from their current location (where we pay high expense ratios plus an “advisor” fee for each monthly deposit) to Vanguard and go index all the way – most likely 70 VTSAX/ 30 VBTLX. BTW, we’re both in our mid-30’s, so that seems like a moderate blend. But how can I, in good conscience, invest 70% of our Roth assets in VTSAX when that bubble is looking quite plump. Do it anyway and just remember, over the long run, it’ll only be a blip on the radar? Or do we move to Vanguard and play it more conservative because of the current climate? Just wanted a second opinion. Keep up the great work, gentlemen! Jonathan – the site looks awesome!

  2. Hi Jonathan and Brad,
    Your podcast has certainly made it to the top of my list! I’ve already got my friends listening. I have a question about my 401k and pension. I recently left my job due to health issues and I am waiting to see if my application for my company’s long term disability insurance will be approved. In the meantime…what do I do with my 401k and pension? I am fully vested. This is a company I worked for for over 16 years. I know you highly recommend Vanguard and I am thinking of heading in their direction. Do you know what kind of fund I can put this money into or have any suggestions?Do I move some of it or all of it? My HR department told me I could leave it for now as the rate of return is doing pretty well. My performance year to date is 6.09%. I really don’t want to rely on the advice from my HR department! And, I don’t want to pay fees to an investment advisor.
    P.S. I have already opened my Chase Sapphire ultimate rewards card and am on my way to travel freedom! Thanks for all the value you have added with your podcast and website. My husband and I are hooked and spread the word every chance we get!
    Sincerely, Heather

    1. Hi Heather, we love that its having an impact and that you are finding it useful. I think you will benefit from episode 19 which will drop in mid april, We interview Jim collins and unpack why we are such big fans of Index funds. If you stick with us you will be an expert on index funds by the end of 2017. If you want to skip ahead, I highly recommend Jim Collins stock series which you can find at jlcollinsnh.com. this answer is very nuanced and would definitely depend on your age but my short answer would be if you are in your 50’s to 60’s you should end with a simple portfolio of VTSAX (Vanguard Total Stock Market Index Fund) and VBTLX (Vanguard Total Bond Market Index Fund) your ratio would depend on whether you were in a wealth accumulation phase or a wealth preservation phase probably 70:30 VTSAX:VBTLX. hope That helps
      Thanks so much for sharing,

  3. Hi Jonathan and Brad.

    Love the podcast! So I am fairly new to the FI world. I just started reading MMM last year and have been making life changes ever since. Moving to a cheaper city, switching jobs and raising our income, walking more and driving less, cooking more at home and because of your previous podcasts decided it was finally time to get a Costco card.

    On the Friday Roundup 2, you guys were talking about Vanguard vs Schwab. I have had a Schwab account for years (before I even had money to invest). At the time, I had opened the brokerage account in order to get their checking account. I travel a lot internationally and a friend of mine had suggested the Schwab checking account for being able to withdraw money overseas. Not only do they not charge ATM fees, they reimburse ATM fees charged by the bank you are withdrawing from and they exchange at the current rate without additional fees. I’ve found it to be the best method while traveling. I always carry some U.S. dollars just in case but prefer to use the ATMs in country with my Schwab debit card for no fee transactions. Since I had their brokerage account, I’ve used their S&P 500 index fund and it has been great. I’m also planning on opening a vanguard brokerage as well and put some money in the Total Stock Market Index fund since pretty much every FI blogger I respect talks about Vanguard. But I’ll probably always keep the Schwab account too for my travels.

    Thanks for all the time and effort you guys put in to creating great content.


  4. Incredible how 1% or 2% can actually shave off 50% or more. Over a lifetime, investment fees can and will cost you millions if you let them. I am a DIY investor and my weighted average expense ratio (essentially only fees outside of some low flat fees in the 401(k)) is 0.08%.


  5. Hi Jonathan and Brad,

    I am new to the FI community and love the concept. I am ready to start applying these recommendations in my life to reach FI as quick as possible. I get the idea of index funds and why they are so great and I am wondering how to best apply it to my situation. My question is:

    Is it better to max out my 401k(w 4% employer match), which is invested though John Hanckock and my only investment options are predetermined categories like aggressive, growth, conservative etc (these have higher fees, my current aggressive option is 1.64% fee).
    Is it better to contribute less money to the 401k (higher fee, less options) and invest the difference into Vanguard index funds(lower fess)?

    I suppose the argument for maxing out the 401k first would be the tax savings every year, however the fees are considerably higher. I would love to hear your thoughts!

    1. Only invest as much as required to obtain all your company match, but no more. Invest the rest in a tax advantaged account with Vanguard.

  6. Hi, is there more information you have how to select the right funds when you’re not an American and live in different countries (unsure of where to retire as a Dutch 28 yr old living in Malaysia)?
    I’ve found a lot of info focussed on the US, and the non-US stuff is a bit more vague, it doesnt really go into the basics of which funds you can consider and why?
    Can’t wait to dive more into your podcast (just learned about it today).


    1. Hi Daan, We definitely started being mostly US centric, but we have received so much interest from all over the world that we are trying to figure out how to expand this message and adapt to other countries. We have a UK path to FI in the works and some international contacts that should be able to help with this.

      so stay tuned and thanks for the question 🙂

  7. I think the idea of index funds is brilliant beyond just the low-cost aspect. They’re extremely diverse yet somehow still constantly yield decent returns.

    Question: I currently have a bunch of money in a Target Retirement fund (Roth IRA). I’m considering moving this money to either and S&P 500 or total market fund, with a percentage in one of the total bond funds. Should I do this? Are there other index funds that are not stock or bonds?

    I was thinking of “hacking” the auto reallocation of the Target Retirement fund in the following matter. Let’s say right now it’s smart to invest 95% in stocks, 5% in bonds. I want to slowly reallocate to 75% stocks and 25% bonds for when I retire. I could put 95% percent of money in a stock index fund and 5% in a bond index fund. Then, when I make my regular, but smaller, contributions, make those contributions 75% to the stock index fund and 25% to the bond index fund (for instance, if I contribute $300 biweekly, put $225 to the stocks, $75 to the bonds). This will slowly move the allocation from 95% stocks 5% bonds to the 75% stocks 25% bonds.

    Of course, my numbers & percents above I just pulled out of thin air. Just a thought.

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