Index Funds Explained: The Simplest Way to Invest (That Somehow Beats Almost Everyone)

boudjeltisalem
Jul 23
25 min read

There’s a stat that genuinely changed how I think about investing, and I want to start with it because it sets the whole tone for this post.

Over the last 20 years, roughly 90% of professional fund managers — people with finance degrees, Bloomberg terminals, teams of analysts, and decades of experience — failed to beat the returns of a basic index fund. Not 50%. Not 70%. Ninety percent.

These are people whose literal full-time job is to pick the best stocks. They get paid hundreds of thousands of dollars a year to do it. And the vast majority of them couldn’t keep up with a fund that basically runs on autopilot.

When I first heard that, my reaction was something like: “Wait… so the best strategy is to just not try?” And the answer is honestly kind of yes. That’s what index funds are. And if you’re a student or a young person trying to figure out where to actually put your money, this is probably the most important concept you’ll learn. Not options trading, not crypto, not whatever that guy on TikTok is yelling about. This.

Let me break the whole thing down from scratch.

What even is an index fund?

An index fund is a type of investment fund that tries to match a specific chunk of the market instead of trying to beat it.

That probably sounds abstract, so let me make it concrete.

You’ve heard of the S&P 500, right? It’s a list of the 500 biggest public companies in the United States — Apple, Microsoft, Amazon, Google, JPMorgan, Johnson & Johnson, all of them. The list gets updated over time as companies grow or shrink, but at any given moment it represents a huge slice of the American economy.

An S&P 500 index fund simply buys shares in all 500 of those companies, in roughly the same proportions that the index uses. So when you buy one share of an S&P 500 index fund, you’re effectively buying a tiny sliver of all 500 companies at once. One purchase, 500 companies. That’s it.

There’s no manager sitting in an office deciding “hmm, I think Apple will do better than Google next quarter, let me buy more Apple.” The fund just mirrors the list. If the S&P 500 goes up 10% this year, the fund goes up roughly 10%. If it drops 15%, the fund drops roughly 15%. It’s not trying to be clever. It’s trying to be accurate.

And here’s the thing — that “just be accurate” approach quietly demolishes almost every other strategy over time. More on that in a minute.

The S&P 500 isn’t the only index

People talk about S&P 500 index funds the most, but there are index funds that track all kinds of things:

Total US Stock Market — instead of just the biggest 500 companies, this covers basically every publicly traded company in America, thousands of them. You get the big ones plus smaller companies too. This is what a lot of long-term investors (myself included) lean toward because it’s even more diversified than the S&P 500.

Total International Stock Market — same idea but for companies outside the US. Europe, Asia, emerging markets, all of it. Some people pair this with a US fund to own a slice of the entire global economy.

Bond Index — instead of stocks, this tracks a broad basket of bonds (basically IOUs from governments and companies). Less growth potential but more stability. Most teens don’t need this yet, but it exists.

Sector-specific indexes — there are indexes for just tech stocks, just healthcare, just energy, just real estate. These are more concentrated, so they carry more risk. I’d skip these when you’re starting out.

The core idea is always the same: instead of picking individual investments, you buy the whole basket. The specific basket just depends on which index the fund follows.

Why index funds beat almost everything (the actual reasons)

It’s not magic. There are real, logical reasons why this boring strategy wins, and understanding them will help you stick with it when some flashy alternative tries to tempt you.

Reason 1: Fees are absurdly low

Every investment fund charges a fee called an expense ratio. It’s a percentage of your money that the fund takes each year to cover its operating costs.

Actively managed funds — the ones where a team of humans is picking stocks — typically charge somewhere between 0.5% and 1.5% per year. That might sound tiny, but it compounds against you in the same way your returns compound for you. Over 30 years, a 1% fee can eat 25-30% of your total returns. That’s not a rounding error. That’s a massive chunk of your money going to pay someone else’s salary.

Index funds? Because there’s no team of analysts to pay (the fund just copies a list), fees are often around 0.03% to 0.10%. Some of the cheapest ones, like Vanguard’s VTSAX or Fidelity’s FZROX, charge basically nothing. Fidelity’s is literally 0.00%.

Over a lifetime of investing, the difference between a 1% fee and a 0.03% fee is genuinely tens of thousands of dollars. Money that stays in your pocket instead of someone else’s. This alone is a huge reason index funds win.

Reason 2: Most stock-picking doesn’t work long-term

This is the part that surprises people. We assume that professionals with all that training and data and resources should be able to pick winners. And some of them do — for a while. But almost none of them do it consistently over 10, 15, 20 years.

Why? A few reasons. Markets are really efficient at pricing in available information, so by the time a fund manager has a “hot take” on a stock, the price usually already reflects that take. There’s also the math of just how many stocks exist and how random short-term movements are. A fund manager might get lucky for three years, attract a bunch of money from people chasing those returns, and then revert to average or worse. It happens over and over.

The data on this is honestly overwhelming. The SPIVA reports (they track active vs. passive fund performance every year) consistently show the same thing: the longer the time period, the worse active managers look compared to index funds. Over 1 year, maybe 40-50% underperform. Over 15 years, it’s 85-90%+. The odds are just not in their favor, and they’re definitely not in yours if you’re trying to stock-pick from your phone between classes.

Reason 3: Diversification is built in

When you own a single stock, you’re betting on one company. If that company has a bad quarter, gets sued, loses a key product, or just falls out of favor — your money takes the full hit.

When you own an index fund that holds 500 or 3,000 companies, any one company having a terrible year barely moves the needle. Some companies in the fund will be down, but others will be up, and historically the overall trend has been upward. You’re not betting on any single company succeeding. You’re betting on the economy as a whole continuing to grow over decades. And that bet has paid off through wars, recessions, pandemics, financial crises — basically every bad thing you can think of.

That’s a fundamentally different kind of risk than picking individual stocks. You go from “I hope this one company does well” to “I believe the global economy will be bigger in 30 years than it is today.” The second bet is a lot easier to feel confident about.

Reason 4: You don’t need to know anything

I mean this in the best way possible. With index funds, you don’t need to read earnings reports. You don’t need to understand P/E ratios or EBITDA or whatever financial jargon people throw around to sound smart. You don’t need to follow the news cycle and panic every time someone says the word “recession.”

You buy the fund. You set up automatic contributions. You go live your life. The fund rebalances itself, adjusts when companies enter or leave the index, and handles everything behind the scenes. Your job is literally just to not touch it.

For someone our age who has school, a job, friends, hobbies, maybe a side project or two — the fact that this strategy requires almost zero ongoing effort is a massive advantage. Time you don’t spend researching stocks is time you can spend on things that actually improve your life right now.

“But what about [famous investor] who beat the market?”

Yeah, Warren Buffett exists. So does Peter Lynch. And a handful of others who genuinely beat the market over long periods.

You know what Warren Buffett himself says regular people should do with their money? Buy index funds. He’s said it in interviews, in his annual letters, and he literally put it in his will — he instructed that 90% of his wife’s inheritance be put into a low-cost S&P 500 index fund. The greatest stock picker alive is telling you not to try to be him.

The few people who beat the market consistently are statistical outliers. For every Warren Buffett, there are thousands of fund managers who thought they were the next Warren Buffett and weren’t. Survivorship bias makes it look like beating the market is more common than it actually is, because you never hear about the funds that quietly underperformed and shut down.

Can you beat the market? Maybe. Some people do. But the odds are heavily against it, the time commitment is massive, and the potential downside is real money lost. When you could just match the market with zero effort and still end up wealthy, why play on hard mode?

ETFs vs. Mutual Funds (same idea, slightly different wrapper)

You’ll see index funds come in two flavors and this confuses people, so let me clear it up.

Index mutual funds are the original format. You buy them at the end of the trading day at whatever the price is when the market closes. There’s often a minimum investment (sometimes $1,000 or $3,000 to start, though some like Fidelity’s have no minimum). You buy them directly through the fund company (Vanguard, Fidelity, Schwab).

Index ETFs (Exchange-Traded Funds) track the same indexes but trade on the stock market like a regular stock. You can buy them anytime during market hours, there’s no minimum beyond the price of one share (often $30–$500, though most brokers now let you buy fractional shares), and you can get them through any brokerage app.

The underlying investment is basically the same. An S&P 500 index mutual fund and an S&P 500 index ETF hold the same stocks and give you the same returns. The difference is mostly about how and when you buy them.

For most of us starting out, ETFs are usually easier because you can buy fractional shares with whatever amount you have, there’s no minimum balance, and you can use whatever brokerage app you already have. But either works. Seriously, don’t let this decision slow you down. Pick one and start. You can always switch later.

The ones people actually buy (real names, real numbers)

I’m not recommending specific investments because I’m a 17-year-old writing a blog, not a financial advisor. But I can tell you which index funds get mentioned constantly in every investing community, book, and forum, and why.

Vanguard Total Stock Market (VTI / VTSAX) — covers essentially the entire US stock market. VTI is the ETF version, VTSAX is the mutual fund version. Expense ratio: 0.03%. This is probably the single most commonly recommended index fund for long-term investors.

Vanguard S&P 500 (VOO / VFIAX) — tracks just the S&P 500 (biggest 500 US companies). Expense ratio: 0.03%. Very similar performance to the total market fund since the biggest companies dominate both. This is what Warren Buffett recommends.

Fidelity Total Market (FSKAX) / Zero Total Market (FZROX) — Fidelity’s versions. FZROX is the “zero” fund with a 0.00% expense ratio. Yes, actually free. The catch? You can only buy it through Fidelity, and it tracks Fidelity’s own index instead of a third-party one. In practice the difference in returns is negligible.

Schwab Total Stock Market (SWTSX) — Schwab’s equivalent. Expense ratio: 0.03%. Same concept.

Vanguard Total International (VXUS / VTIAX) — for the non-US portion. Some people do an 80/20 or 70/30 split between US and international. Expense ratio: 0.07%.

Notice something? They’re all basically the same concept from different companies, with nearly identical and extremely low fees. This is not a decision worth agonizing over. They’re all good. Whichever brokerage you end up using, they’ll have their version, and it’ll be fine.

What returns can you actually expect?

Let’s talk real numbers because vague promises help nobody.

The US stock market (as measured by the S&P 500) has returned an average of roughly 10% per year before inflation, or about 7% per year after inflation, over the last several decades. That’s the long-term historical average.

But — and this is important — “average” hides a lot of volatility. Some years the market is up 30%. Some years it’s down 30%. The average only shows up when you zoom out over 10, 20, 30+ year periods. In any given year, anything can happen.

Here’s what $200/month into an index fund looks like over time, assuming that historical ~7% real return (after inflation):

• After 5 years: ~$14,000 (you put in $12,000)

• After 10 years: ~$33,000 (you put in $24,000)

• After 20 years: ~$99,000 (you put in $48,000)

• After 30 years: ~$227,000 (you put in $72,000)

• After 40 years: ~$480,000 (you put in $96,000)

That last one is the one that should make you stare for a second. You put in $96,000 over 40 years, and you end up with almost half a million. The other ~$384,000 is growth. That’s compounding doing its thing over a long runway, and it’s exactly why starting at 17 instead of 30 is such a big deal. You have more runway than almost any other investor reading finance blogs right now.

These numbers aren’t guarantees. The future could look different from the past. But the historical track record is long enough and consistent enough that betting on “the economy will grow over the next 40 years” is about as reasonable a bet as you can make.

The emotional part nobody warns you about

Here’s the thing that all the math and logic in the world can’t fully prepare you for: watching your money drop and doing nothing about it is hard.

At some point after you start investing, the market will drop. Maybe 10%, maybe 20%, maybe more. Your $2,000 will suddenly be $1,600 and every instinct in your body will scream “SELL BEFORE IT GETS WORSE.” Financial Twitter will be melting down. News headlines will say words like “crash” and “correction” and “worst day since 2008.” Your parents might get nervous. Your friends who don’t invest will say “see, told you the market was a scam.”

And you have to sit there and do nothing.

Actually, no. You have to sit there and keep buying. Because a drop means everything is on sale. Your regular monthly contribution now buys more shares at a lower price, which means when (not if) the market recovers, you benefit more than if you’d paused.

Every single market crash in history has eventually recovered and gone on to new highs. Every one. The 2008 financial crisis, the 2020 COVID crash, the dot-com bubble — all of them. The people who got hurt were the ones who sold during the panic. The people who kept buying are the ones who ended up wealthy.

This is genuinely the hardest part of index fund investing. Not the strategy. Not picking the right fund. Not the math. Just… sitting still when everything feels like it’s falling apart. If you can master that, the rest is easy.

A trick that helps me: I don’t check my portfolio when the news is bad. Not because I’m pretending it’s not happening, but because looking at the number doesn’t change anything and it just makes me anxious. I already know my plan (keep buying, don’t sell) so seeing the number go down doesn’t give me any useful information. It only tempts me to do something dumb.

Common questions I get (and the honest answers)

“Should I just buy one index fund or several?”

Starting out? One total-market fund is genuinely enough. You can complicate it later by adding international exposure or bonds as you learn more, but one total US market fund already gives you thousands of companies. Don’t let portfolio optimization become the reason you never start.

“What about dividends?”

Some index funds pay dividends (small cash payments from the companies in the fund). Most index funds give you the option to automatically reinvest those dividends, which means they just buy you more of the fund. Turn this on and forget about it. Free compounding.

“Is now a good time to start?”

Yes. Also yes if you asked me this six months ago, or six months from now. Time in the market beats timing the market — this has been studied extensively, and the data is clear. People who invested at the absolute worst time each year still ended up ahead of people who kept their money in cash waiting for the “right moment.” Stop waiting. Start buying.

“What if the market crashes right after I invest?”

Then you got a discount and you keep buying. You’re 17 (or close to it, if you’re reading this blog). A crash now is genuinely a gift because you get to accumulate shares at lower prices for years. A crash only hurts people who need their money soon, and we already talked about not investing money you’ll need in the next 5 years.

“Isn’t this basically settling for average returns?”

This is the best misconception to clear up. You’re not getting “average” in the sense of mediocre. You’re getting the market’s total return, which historically has been incredibly good. “Average” here means you’re doing better than 85-90% of professionals. That’s not settling. That’s winning by choosing not to play a game that’s rigged against individual players.

“What about crypto? What about individual stocks? What about options?”

Look, I’m not going to tell you to never touch any of those. But I will say this: get your foundation right first. An index fund on autopilot should be the core of what you do with your money, the boring 80-90% that you never think about and that quietly makes you wealthy over decades. If you want to take 10% of your investing money and experiment with individual stocks or whatever, go for it — but only after the boring base is in place. Most people do it backwards. They start with the exciting stuff, lose money, get discouraged, and never build the foundation at all.

The one-page version of everything above

If you scrolled straight to the bottom, here’s the whole post in a few lines.

Index funds track the entire market instead of trying to pick winners. They charge almost nothing in fees, they outperform roughly 90% of professional stock pickers over the long run, and they require basically zero ongoing effort. You buy one fund (a total US market or S&P 500 index fund), automate monthly contributions, reinvest dividends, and don’t touch it for decades. The market will go down sometimes and you’ll feel sick. Keep buying anyway. Every crash in history recovered. Time is the engine, consistency is the fuel, and being young is the biggest advantage you’ll ever have.

That’s the whole strategy. It’s boring. It works. And 40 years from now, you’ll be very glad you learned about it at 17 instead of 40.There’s a stat that genuinely changed how I think about investing, and I want to start with it because it sets the whole tone for this post.