-- Q: I just got a $10,000 inheritance and I'm thinking about buying an index fund that tracks the Standard & Poor's 500. Is that lame? Should I be taking more chances with my money?
A: I can understand why you might not be excited about buying a stock index mutual fund. By definition, an index mutual fund that tracks the Standard & Poor's 500 index will perform no better (or worse) than the index. When the market goes up 10%, you'll be up 10%. And there will inevitably be a cousin at a family reunion bragging about a stock she owns that doubled in two weeks.
But here's the better way to look at it: When the market gains 10%, you'll get the 10% return you're entitled to. It's pretty typical for investors who try to time the market and pick winning stocks to have terrible timing and make some bad picks. When that happens, they will gain less than 10% or even lose money when the market is up 10%.
There's another benefit to index investing. Fees are low. You can buy an index mutual fund that tracks the S&P 500 that charges less than 0.15% as an annual expense ratio. In comparison, many mutual funds with human stock pickers charge 1.0%, 1.5% or more. If you buy an index mutual fund instead of a mutual fund charging 1.5%, you're already ahead by 1.5 percentage points before the trading begins.
I'd like to make one last point. Don't think that by buying index mutual funds or exchange-traded funds (ETFs), you're limited to the S&P 500. You can buy index funds that track areas that have higher returns, such as small value-priced stocks, emerging markets and foreign stocks. By owning several funds or ETFs that track different indexes, you can adjust your overall risk and generate returns that would be higher than if you just invested in the S&P 500.Remember that with higher potential returns comes higher risk.
Investing in a mutual fund that owns the S&P 500 is a great way to start. As you get more comfortable, you should add funds that own other indexes to lower your risk further. You can also add mutual funds that own bonds, to lower your overall risk.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at email@example.com. Click here to see previous Ask Matt columns.