Two Reasons Index Funds are FAB: cheap and easy diversification.
You don’t want only one kind of pie in your portfolio. Because what if all the sudden nobody buys that pie anymore and it becomes worthless? An investor wants all different kinds of pie slices in their portfolio. But the problem for individual humans who want to invest is that buying loads of different kinds of pie slices is super expensive and not really do-able.
On the other hand, if a bank pools together a bunch of money from a bunch of investors, they can buy a whole bunch more pie than the investors could on their own.
If the bank puts together a nice basket for you, with a little mulberry, a slice of strawberry, maybe a little chocolate bourbon pecan, it can give you way more kinds of pies and way more of them than you could buy on your own.
On your own you could buy one slice of strawberry, 2 blueberries and a lemon merengue, or you could get a bank combo special basket and get a thousand different kinds of slices for the cost of those 4 slices you bought. This means your portfolio will be more diverse, which theoretically exposes you to less risk.
How do you, the investor, choose which baskets to buy?
There are two main things to consider when you buy your baskets: How much they cost, and what your investing goals are.
If you want to invest as cheaply as possible over the long term, then low cost index funds are for you. This is most people.
Maybe you want your investments to reflect your values. Then you could choose an ETF that has environmentally-friendly stocks, like CRBN or one that promotes gender diversity, like SHE. Selecting stocks this way is called “Sustainable Investing” or “ESG Thematic”-meaning that they focus on an Environmental, Social or Governance issue.
(I am not recommending these ETFs, just mentioning that they exist.)
For example, the SPDR’s S&P 500 index fund, ticker symbol, SPY has an expense ratio of .09 vs Vanguard’s S&P 500 index fund with an expense ratio of .03.
Vanguard’s S&P 500 index mutual fund has an expense ratio of .04.
Invesco funds’ Nasdaq 100 index ETF, ticker symbol, QQQ (aka “The Q’s”), is more costly with an ER of .20.
The Gender diversity index fund I mentioned above, SHE, has an ER of .20 as well.
In summary: low cost index funds should be the bulk of your stock market investing portfolio if you’re a long term buy and hold investor. They reliably perform (as reliably as any stock market product can perform) and fees are minimal.