Index Funds, Explained With the Math
An index fund owns the whole market for a tiny fee. Here is how a 0.03% expense ratio beats a 1% managed fund over thirty years.
What an index fund actually is
An index fund buys every stock in a market index in proportion, then does almost nothing. Because it does not pay managers to pick winners, it charges very little. You own the market's average return, minus a sliver.
The fee is the only reliable predictor
You cannot predict returns, but you can predict costs. Over thirty years the fee is the one number you control, and it compounds against you.
The arithmetic
Start with 10,000 and assume the market returns 7% a year before fees.
- A fund charging 0.03% nets 6.97% and grows to about 75,900 after 30 years.
- A fund charging 1.00% nets 6.00% and grows to about 57,400 after 30 years.
The 0.97% gap in fees costs about 18,500 over three decades. That is not a one-off charge; it is a slice taken every year from a growing base.
Why the managed fund rarely wins
After costs, most actively managed funds underperform their index over long periods. A few win for a while, but identifying them in advance is the hard part, and past winners do not keep winning.
How to use it
Pick a broad index, check the expense ratio is near the floor, buy regularly, and leave it alone. Boring is the feature.
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