This article is an excerpt from the Shortform book guide to "The Wealthy Barber" by David Chilton. Shortform has the world's best summaries and analyses of books you should be reading.
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Should you invest in index funds? Are they better than mutual funds?
In The Wealthy Barber, David Chilton argues that the best thing you can do to reach financial success is to invest 10% of your income in mutual or index funds. Then, sit back and take advantage of the compound interest. He explains what index funds are and why he believes they are a better investment than mutual funds.
Keep reading for index fund advice from Chilton and others.
Investing in Index Funds
An index fund is a type of mutual fund that’s passively managed. In an index fund, your money is only invested in the stocks that make up the index, which seeks to mirror the components of a market index. Market indexes are themselves designed to reflect the state of the financial market. Two well-known examples of market indexes are the Dow Jones Industrial Average, which tracks the performance of the 30 largest US companies, and the S&P 500, which follows the 500 largest US companies.
Should you invest in index funds? Chilton says yes. Index funds have two main advantages over mutual funds. One, they are cheaper than mutual funds, because they don’t require active management. Two, they generally perform better than mutual funds over time. Mutual fund managers try to beat the market, which is very hard to do; with index funds, you’ll at least match the market’s performance.
(Shortform note: While Chilton notes the advantages of index funds over mutual funds, he nonetheless recommends both as sound investment choices. Many personal finance books disagree with this approach. For example, in I Will Teach You to Be Rich, Ramit Sethi advises avoiding mutual funds altogether, as many firms hide poor performance by dropping funds that fail and ranking only the funds that perform well. JL Collins says in The Simple Path to Wealth that you should choose index funds over mutual funds because index funds get better results and have lower fees. Similarly, Tony Robbins claims in Money: Master the Game that 96% of professional money managers lose against the market over the long term.)
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Here's what you'll find in our full The Wealthy Barber summary :
- A guide to becoming financially successful by following simple principles
- Why you might not need to buy life insurance
- Why you should only buy a house if it’s right for you
