Author Topic: My understanding of Index funds - what gives?  (Read 4611 times)

cbr shadow

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My understanding of Index funds - what gives?
« on: June 05, 2013, 01:23:48 PM »
I keep reading that Stock Index Funds are a good way to go.  I invest pretty heavily in them.  The thing that I dont really understand is HOW they work. For example, I have a lot in VTSAX.. If you look at a chart from the last 10 years VTSAX rollercoasters up close to $40, then back down, then up near $40 again, then back down.  Recently it went over $40, but has been taking a bit of a drop and headed down again.  I'm in it for the long run so I dont mind the rollercoaster, but how is it possible to end up with more money in the end if it's not continuously improving (meaning always staying above $40, then higher).  I know VTSAX doesn't pay much in dividends, so it needs to always be growing for people like me to make money in the long-term, right?
Please correct me if anything above is incorrect.

Thanks!

bUU

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Re: My understanding of Index funds - what gives?
« Reply #1 on: June 05, 2013, 01:27:56 PM »
Dividends don't govern how much the fund shares themselves are worth. If there are dividends, and you wish to reinvest them, then you can buy more shares, but the added value there then is due to you having more shares.

When you buy into an index fund you're effectively buying a small share of every holding in the market. The value of the fund goes up and down in step with the aggregate success of the holdings themselves. VTSAX, specifically, increases in value because domestic companies have, themselves, increased in value, such that their shares are worth more.

matchewed

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Re: My understanding of Index funds - what gives?
« Reply #2 on: June 05, 2013, 01:35:49 PM »
What bUU said. Also remember investing is a long game not a short one. Day to day/week to week/month to month hell even year to year swings have little meaning in the index fund style of investing. Just keep DCAing.

Historically speaking the markets trend upwards. That is what you're banking on for future growth. What you're banking on for immediate growth in the short term is your ability to save a large portion of your income.

AlexK

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Re: My understanding of Index funds - what gives?
« Reply #3 on: June 05, 2013, 01:36:59 PM »
I see VTSAX up 100% since early 2003 but anyway, 10 years is a short period of time for the stock market. It can stay low for decades and exhibits wild swings but over long time periods (few decades) grows faster than other asset classes.

Over the past century the US stock market has averaged about 10% in dollars and 6.2% above inflation. So don't expect miracles out of it but actually 6.2% compounded over a few decades seems like a miracle.

cbr shadow

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Re: My understanding of Index funds - what gives?
« Reply #4 on: June 05, 2013, 01:38:06 PM »
I understand that part of it, but how do we make money with index funds if they keep maxing at ~$40 and then go back down into the $30's.  Isn't there an assumption that the index funds will either constantly increase as a whole, or else it's staying stable as you get dividends and reinvest (therefor making money)?

Example: I buy VTSAX right now at $40.  It goes up to $43, then down to $36, then 10 years later it's back around $40.  Without dividends I've made $0 over 10 years, right?

cbr shadow

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Re: My understanding of Index funds - what gives?
« Reply #5 on: June 05, 2013, 01:39:54 PM »
Looks like the previous 2 posts got in there before me.  It sounds like I'm just looking too short-term to see that there's always a constant increase.

Cecil

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Re: My understanding of Index funds - what gives?
« Reply #6 on: June 05, 2013, 01:46:29 PM »
Look at something with a longer timeline, like a 40-year history of the S&P 500: https://www.google.ca/finance?q=INDEXSP%3A.INX

Your 10-year window is merely part of a larger trend. You could say the same thing about 1980: "How is it possible to make money if the index rarely goes about 100?"

matchewed

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Re: My understanding of Index funds - what gives?
« Reply #7 on: June 05, 2013, 01:52:05 PM »
In after your next comment but still relevant to illustrate the point like Cecil did as well.

In your specific scenario you are right. But let's look at the VTSMX since 1996 over the long enough time frame it goes up. Add that to the dividend payout and you have your gains.

Spork

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Re: My understanding of Index funds - what gives?
« Reply #8 on: June 05, 2013, 03:43:26 PM »
...and don't forget dollar cost averaging.   If you're investing $X a month, yeah that $X you invested in October 2007 is only up about $5 a share.  BUT... that $X you invested in February 2009 is up $23 a share (and has almost doubled). 

So, yeah, it may seem like it isn't up much ... but if you're buying when it is up and you're buying when it's down, overall, you'll end up making more.  (And you won't require a crystal ball to time the market.)

sheepstache

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Re: My understanding of Index funds - what gives?
« Reply #9 on: June 05, 2013, 05:54:17 PM »
Looks like the previous 2 posts got in there before me.  It sounds like I'm just looking too short-term to see that there's always a constant increase.

Yes, in the past ten years, we had a major recession and the market is still recovering from that so some stuff just got back the value level it was at 10 years ago.

Another thing to consider is fund share splits.  I don't think this applies to VTSAX, but, like stocks, mutual funds can split shares when the price climbs higher than desired.  So for example if a fund is $100, the managers may decide to do a 2 for 1 split.  The new price is $50 per share, so on a graph it looks like the price fell.  But each holder received two of the new shares for every one that they held before, so no value has been lost.

cbr shadow

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Re: My understanding of Index funds - what gives?
« Reply #10 on: June 06, 2013, 07:24:30 AM »
Lots of good info here - thanks everyone.

COguy

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Re: My understanding of Index funds - what gives?
« Reply #11 on: June 06, 2013, 11:51:26 AM »
Sounds like you need to read about how the capital markets really work.  Even though I run a simple 3 index fund portfolio, I read all the time so I know exactly why I own what I own. 

You can read William Bernstein, Burton Malkeil, Ben Graham, Warren Buffet and others.  Or, if you like the internet I recommend:

http://www.longtermreturns.com/ -a great site that digs into the why of indexing
http://www.joshuakennon.com/ -don't act on the individual business valuation tips, but use them to understand how the capital markets work.  Joshua does a great      job of explaining the stock market

If you read everything on those two site plus the investing books on MMM recommends you will most likely get more clarity as to the why.  Also, never stop asking why when it comes to your money.