Indexing: A powerful, low cost way to invest.

Index investing, sometimes referred to as passive investing, is typically done by investing in a mutual fund or exchange-traded fund (ETF) that aims to track a particular index. This type of investing strategy can be appealing if you don't have the time or experience to research which specific stocks, bonds, or other investments you may want to include in your portfolio.

What are index funds

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CHARLES SCHWAB:

It's a very simple decision: 'Do I have enough money each month to put aside, and where should I put it?'  My recommendation is to put it in an index fund, particularly as a younger starting investor.

One of the great features of index funds, and broad-based, ETFs, is that you get the advantage of broad diversification, you get many stocks. 

So if you, let's say, invest in an index fund or some… the S&P 500, it would be 500 companies.  They represent about 70% of Americans' value of stocks.  We have a fund called the Schwab 1000.  It's a thousand stocks, represents about 85% of the companies' value in the United States.  That is, of course, very broad diversification, and so if there's one industry that goes up, oil, for instance, and another one going down, utilities going down, you have an investment in every major, ah, sector of the economy

VOICEOVER:

In the first video of this series, we looked at the importance of investing in stocks to grow your wealth.

But choosing the companies and industries that will deliver the best earnings growth is a real challenge.

Competitive trends, management's ability to execute on their plans and unpredictable events, make it very hard to forecast results with success and consistency

Most people just don't have the interest, time or expertise to pick individual stocks well.

Multiply that effort by the many individual stocks you'll likely need for a well-rounded portfolio and the complexity adds up quickly.

Research shows how difficult it is even for the pros to actively buy and sell individual securities and match the market's performance. 

So to get the best chances of building a portfolio that is designed to grow, and to get invested in as many different companies in as many different sectors as you need to be well diversified, what do you do?

One of the easiest and low cost ways to get invested in as many companies as possible is to invest in a mutual fund or an exchange traded fund – an ETF –to own a basket of companies. And a smart approach to that is index investing, which provides two important advantages – diversification and minimizing costs.

You're probably already familiar with indexes such as the S&P 500, DOW Jones, or the NASDAQ.

In fact, when people talk about the stock market, they're usually thinking about an index.

And while you can't invest directly in an index, many mutual funds and exchange traded funds, or ETFs, track these indexes, often simply holding the same stocks in the same proportions as are in the index.

Index funds can give you broad exposure to the market. Some are so broad, in fact, that buying them means you own a tiny piece of almost every public company in America, with just one investment!

Index investing can be a useful tool for both experienced and inexperienced investors, to form the core of a well-diversified portfolio.

When it comes to investing, controlling costs is important. In fact it's one of the few things you can control.

Index funds are typically low cost compared to either buying stocks individually, where you pay a commission for each purchase or sale, or investing in actively managed funds that choose stocks and make trades.

And with the advent of ETFs, costs dropped dramatically.

Now, you can get access to the entire US broad stock market for an annual expense of .03%.

That means that on a $10,000 investment, your expenses would be $3 a year to own about 2,000 stocks!

Lower costs means more money stays working in your portfolio. And, over time, this can have a big impact on your outcome.

CHARLES SCHWAB

To me, there's lots of confusion in the discussion about investing, and you want to make it simple.  Some parts of the industry make it too complicated.  Look for the firms, look for people who make it simple for you. 

 

Definitions:

The Dow Jones Industrial Average™, also referred to as The Dow®, is a price-weighted measure of 30 U.S. blue-chip companies. The Dow® covers all industries with the exception of transportation and utilities, which are covered by the Dow Jones Transportation Average™ and Dow Jones Utility Average™.

The NASDAQ Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks.

The S&P 500® Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity and industry group representation
.

 

Disclosures:

Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.

Investing involves risk, including possible loss of principal.  Broker-assisted trades may have additional charges.

Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab Funds®, and Charles Schwab & Co., Inc. (Schwab), Member SIPC, the distributor for Schwab Funds, are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation. CSIM is the investment advisor for Schwab ETFs™. Schwab ETFs are distributed by SEI Investments Distribution Co. (SIDCO), One Freedom Valley Drive, Oaks, PA 19456. SIDCO is not affiliated with CSIM.

 

 

©Charles Schwab & Company, Inc. ("Schwab"). All rights reserved. Member SIPC (2017-UPJA)

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The advantages of indexing.

Sometimes a simple, straightforward approach is best. Index funds provide the benefit of diversification, and they tend to be cost effective and tax efficient. Investing in index mutual funds and index ETFs allows you to own multiple companies without regularly choosing which ones to buy or sell, and offers the following benefits.

Low fees

Expenses erode returns over time. There are fees associated with any investment. But over time, the fees you pay can really add up, which is why low-cost index investing can leave more of your money invested for growth. 

The average actively managed mutual fund charges 0.50% in annual fees. The average index fund charges 0.06% in annual fees

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Information about the Low Fees chart


Source: For illustrative purposes only. These projections assume a 5% rate of return, are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Fees will impact your portfolio even during periods of negative market performance. The chart does not reflect all fees that may be charged and is not representative of any actual investment, product, or fee structure.



Performance

By definition, index funds aim simply to track their benchmark indexes before fees and expenses. Actively managed funds may fall short of market indexes over time.² Over the 5- and 10-year periods ending June 30, 2022, the average active equity fund manager lagged the broader market, as represented by the Schwab 1000 Index®.

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Information about the Performance Chart


Source: Charles Schwab Investment Advisory (CSIA) with data from Morningstar, Inc. Fund return is the weighted average time-weighted return of all active funds in the following Morningstar categories: US Fund Large Blend. Each fund is represented by its oldest share class. US market index returns are represented by the Schwab 1000 Index. Index returns assume reinvestment of dividends and interest. Indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no indication of future results.



Tax efficiency

Index mutual funds and ETFs tend to have low turnover—meaning they buy and sell securities less frequently—potentially generating fewer capital gains.

Over time, returns lost to taxes add up. In this hypothetical example, $100,000 invested in an active equity fund would have lost over $6,700 more to taxes over 10 years compared to an index equity fund.

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Information about the Tax Efficiency chart


Source: Charles Schwab Investment Advisory, Inc. (CSIA) gathered data on all of the unique equity mutual funds with at least 10 years of performance in the Morningstar Direct database as of 6/30/2022 (2,282 funds). The average 10-year tax cost ratio was calculated for the index funds and the non-index funds in that group. Tax cost ratio is a Morningstar measure of how much an investor in the highest bracket would have lost each year to federal income taxes due to fund distributions. The tax cost ratio for each fund type (index and non-index) was subtracted from the S&P 500®'s average return over that time period (12.96% per year), and that net-of-tax-loss return was used to calculate how much $100,000 would have grown over the 10-year period.



Diversification

The spreading out of risk is a key tenet of investing. Mutual funds and ETFs, including index funds, can provide portfolio diversification. Some index funds provide exposure to thousands of stocks—or almost the entire investable equity universe.

Diversification spreads the risk of a portfolio. The more stocks in a portfolio, the lower the chance that one stock could cause a significant decline in portfolio value.

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Info about the Diversification chart


Source: Schwab Center for Financial Research.⁴ This example shows the mathematical probability of losing money in a single year when the market return is 6% if the investor selects stocks at random (i.e., has no stock selection skill). Calculations include standard deviation assumptions of 11%, 8%, and 6.5% for the 5-, 20-, and 40-stock portfolios, respectively, and assume a normal distribution of returns. Analysis assumes that a randomly selected stock returns 6% annually, has a standard deviation of 20%, and is 10% correlated with every other stock in the market.


Ready to start investing in index funds?

Access low-cost index funds and ETFs from an industry leader.

Since 1991, Schwab has provided clients with new ways to access efficient, cost-effective, index-based investments.

  • Schwab Asset Management™ is the third-largest provider of index mutual funds.

  • Schwab Asset Management also holds $340.8 billion in Schwab index mutual funds and Schwab ETF assets under management.

  • Schwab has over 30 years of indexing experience—and the expertise to show for it.

See below how Schwab index mutual funds and ETFs stack up against the industry average. If you're an investment professional, learn more about Schwab funds.

All rankings are based on Schwab Asset Management's assets under management (AUM) as of June 30, 2022.

Get low-cost market cap index mutual funds with no minimum investment required.

Mutual funds tables

Name Ticker OER Tooltip Morningstar Institutional Category Category Average OER
Schwab Total Stock Market Index Fund® SWTSX
0.03% Large Core 0.40%
Schwab S&P 500 Index Fund SWPPX 0.02% S&P 500 Tracking 0.44%
Schwab 1000 Index® Fund SNXFX 0.05% Large Core 0.40%
Schwab U.S. Large-Cap Value Index Fund SWLVX 0.035% Large Core Value 1.06%
Schwab U.S. Large-Cap Growth Index Fund SWLGX 0.035% Large Core Growth 0.38%
Schwab U.S. Mid-Cap Index Fund SWMCX 0.04% Mid Core 0.42%
Schwab Small-Cap Index Fund® SWSSX 0.04% Small Core 0.49%
Name Ticker OER Morningstar Institutional Category
Category Average OER
Schwab International Index Fund® SWISX 0.06% Foreign Giant 0.17%
Name Ticker OER Morningstar Institutional Category
Category Average OER
Schwab U.S. Aggregate Bond Index Fund SWAGX 0.04% Intermediate Investment Grade (4-6) 0.24%
Schwab Short-Term Bond Index Fund SWSBX 0.06% Short-Term Investment Grade 0.16%
Schwab Treasury Inflation Protected Securities Index Fund SWRSX 0.05% Inflation-Protected Bond 0.10%

This table compares Schwab market cap index mutual funds to the average operating expense ratio (OER) within each mutual fund's respective Morningstar Institutional Category as determined by Morningstar. The industry average OER is a straight average of all index mutual funds assigned to the Morningstar Institutional Category. Information shown above as of September 2022.

Learn more about mutual funds managed by Schwab.

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Get low-cost market cap index ETFs.

ETF Tables

Name Ticker OER Morningstar Institutional Category
Category Average OER
Schwab 1000 Index® ETF SCHK 0.05% Large Core 0.35%
Schwab U.S. Broad Market ETF SCHB 0.03% Large Core 0.35%
Schwab U.S. Large-Cap ETF SCHX 0.03% Large Core 0.35%
Schwab U.S. Large-Cap Growth ETF SCHG 0.04% Large Core Growth 0.44%
Schwab U.S. Large-Cap Value ETF SCHV 0.04% Large Deep Value 0.30%
Schwab U.S. Dividend Equity ETF SCHD 0.06% Giant Value 0.19%
Schwab U.S. Mid-Cap ETF SCHM 0.04% Mid Core 0.35%
Schwab U.S. Small-Cap ETF SCHA 0.04% Small Core 0.26%
Schwab U.S. REIT ETF SCHH 0.07% Domestic Real Estate 0.39%
Name Ticker OER Morningstar Institutional Category
Category Average OER
Schwab International Small-Cap Equity ETF SCHC 0.11% Foreign Small/Mid Core 0.39%
Schwab International Equity ETF SCHF 0.06% Foreign Large Core 0.31%
Schwab Emerging Markets Equity ETF SCHE 0.11% Diversified Emerging Markets 0.47%

Schwab International Dividend Equity ETF SCHY 0.14% Foreign Large Value 0.41%
Name Ticker OER Morningstar Institutional Category Category Average OER
Schwab Municipal Bond ETF SCMB 0.03% Muni National Intermediate 0.17%
Schwab 1-5 Year Corporate Bond ETF SCHJ 0.03% Short/Intermediate Investment Grade (2.5-4) 0.12%
Schwab 5-10 Year Corporate Bond ETF SCHI 0.03% Long Investment Grade (>6) 0.15%
Schwab U.S. Aggregate Bond ETF SCHZ 0.03% Intermediate Investment Grade (4-6) 0.19%
Schwab U.S. TIPS ETF SCHP 0.04% Inflation-Protected Bond 0.17%
Schwab Short-Term U.S. Treasury ETF SCHO 0.03% Short-Term Government 0.10%
Schwab Intermediate-Term U.S. Treasury ETF SCHR 0.03% Intermediate Government (4-6) 0.06%
Schwab Long-Term U.S. Treasury ETF SCHQ 0.03% Long Government (>6) 0.12%

This table compares Schwab market cap index ETFs to the average operating expense ratio (OER) within each ETF's respective Morningstar Institutional Category as determined by Morningstar. The industry average OER is a straight average of all index ETFs assigned to the Morningstar Institutional Category. Information shown above as of November 2022.

Learn more about Schwab ETFs.

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More choices and guidance.

As a Schwab client, you can access even more index funds and expertise.

  • Select from over 2,000 index mutual funds and ETFs from Schwab Asset Management and other providers.
  • Choose from more than 200 index mutual funds with no transaction fees and $0 commission online on all index ETFs from Schwab Asset Management and third-party providers.³

More options and guidance.

  • Fund Finder Tools

    Do-it-yourself using our Fund Finder tool to screen and compare index mutual funds and index ETFs.

  • Personalized Portfolio Builder

    If you want a little help, use our free Personalized Portfolio Builder to help you create a diversified portfolio of mutual funds or ETFs that meets your needs.

Take the next step.

Ask us your questions

Index investing is the practice of investing in a fund—whether a mutual fund or an ETF—with a portfolio of securities that track a particular index. It is a straightforward way to participate in the potential growth of the economy over time. 

Methods of index construction vary widely. The securities may be chosen by a committee based on pre-defined criteria, or the criteria may completely prescribe the securities to be included (for example, the 1000 largest companies). Then, the components of the index are weighted to determine their representation. Most of the broadly used stock indexes are capitalization-weighted, meaning that a company’s size (in terms of its market capitalization, or the total value of its outstanding shares) determines its weight in the index.

 

However, there are other ways to weight the components of an index, including various "smart beta" strategies.

 

The methodologies describing how index portfolios are selected and weighted are available to the public. This differs from actively managed funds, where the weighting and selection of securities is usually a proprietary process. (Because the success of an active strategy depends on the fund manager's expertise, the specific methodology is unlikely to be advertised.)

Although both aim to track indexes, index mutual funds and ETFs differ in how they are structured, bought and sold.

 

ETFs, which can only be purchased through a brokerage account, trade like stocks continuously throughout the day. When you buy or sell an ETF, you do so from another market participant, not the fund company. The other buyer or seller may be an individual investor like you—but is more often a firm that specializes in buying and selling ETFs (known as a market maker).

 

Since ETFs are not purchased directly from the fund company, the price at which they trade may differ from their net asset value (NAV). Most large and well-known ETFs trade at prices very close to NAV, but smaller and less-liquid ETFs may have market prices that temporarily deviate from their NAV.

 

Mutual funds, on the other hand, are purchased directly from fund companies and are priced just once daily—when their net asset value is determined after markets close.

 

Due to their different structure, there are different costs associated with trading ETFs versus mutual funds, including, potentially, trading commissions and bid-ask spreads.

 

Which is right for you depends largely on your investment schedule and strategy.

Indexes are not investment products, but rather intellectual property (similar to the difference between a house and the blueprints necessary to build a house). While indexes describe how to construct a portfolio, it’s the job of the fund manager to actually build and manage the portfolio.

 

Tracking difference and tracking error are used to measure how well an index product is replicating its index. Most index-tracking ETFs and mutual funds do a fine job of matching their indexes; however, there are always exceptions to any rule.

Investors in an index mutual fund or ETF participate in the growth of the market segment represented by the index, but markets don't always rise. And when the market is in decline, "owning the market" means participating in the full decline. Market outperformance—which index investments cannot and do not aim for—isn't just about maximizing gains; it's also about minimizing losses during a downturn.

 

It's also possible that owning an index investment could give an investor a false sense of diversification based on the sheer number of securities included in a particular index. Investing in just one index fund, even if it is based on an index with hundreds of securities, doesn't mean a portfolio is completely diversified. Portfolio diversification ideally involves multiple asset classes and geographical markets, minimizing the correlations between holdings. This can be achieved with index funds, actively managed funds or a combination of both.

Actively managed funds offer the potential to beat the market—and may help reduce downside risk and volatility. So they can indeed play a valuable role in your diversified portfolio. When you're paying for active management, however, you may want to consider the active manager's tenure and the fund objective. 

Schwab Asset Management is able to offer these products at competitive costs because we are committed to operating our business through client's eyes and sharing the benefits of our scale and efficiency with investors.

Market cap mutual funds and ETFs tend to be categorized by their portfolio holdings as multi-, large-, mid-, and small-cap.

 

Multi-cap funds are those that can include large-, mid-, and small-cap holdings. 

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