Faith & Finance - Understanding Index Funds with Benji Bailey

Did you hear about the guy who owned last year’s top-performing funds? Yeah, it's too bad he bought them this year, though.

There’s a lot of evidence to suggest that buying and holding index funds will pay off in the long run. Benji Bailey joins us today to make the case with some impressive numbers.

Benji Bailey is Vice President of Investments and Senior Fixed Income Manager at Praxis Mutual Funds, an underwriter of Faith & Finance.

The Importance of Indexes in Investing

To understand index funds, we can view them like guideposts in a national park. Just as signs direct visitors to scenic views and help them stay on the right path, indexes serve as essential benchmarks for investors. These benchmarks, such as the S&P 500 for large-cap stocks or the Bloomberg Aggregate for bonds, allow investors to measure their progress toward financial goals.

Without these guideposts, investors risk straying off course, possibly realizing too late that their portfolio has been heading in the wrong direction. Publicly available indexes provide a crucial check-in, ensuring investments align with long-term objectives.

Many investors believe they can outperform the market by actively trading stocks. However, research suggests otherwise. A study published in The Journal of Finance found that individuals who frequently traded stocks underperformed compared to those who traded less.

Over a six-year period:

• The market returned approximately 18% annually.
• Less active traders saw returns of around 16.4%.
• The most active traders only achieved 11.4%, underperforming by over 6%.

This trend highlights the dangers of excessive trading. Warren Buffett summarized it well: “The stock market is designed to transfer money from the active to the patient.” The Bible echoes this wisdom in Proverbs 13:11: “Wealth gained hastily will dwindle, but whoever gathers little by little will increase it.”

Active vs. Passive Mutual Funds

A key distinction in investing is the difference between active and passive mutual funds:

• Active funds: Managed by professionals who handpick a smaller set of stocks, hoping to outperform the market.
• Passive funds: Designed to mirror an index, holding a broad range of stocks for stable, long-term growth.