Are index funds good investments for retirement? If you’ve done any amount of reading on investment strategies, you have certainly heard about index investing. In this article I’m going to explain WHAT index investing is and WHY it is such a good strategy for your retirement.

This article goes a little deeper into market theory, so I want to give you the bottom line up front.

1. Index investing simplifies investment selection. When you invest in an index, you are investing in all of the stocks that make up the index and make no attempt to pick the “best” ones. That is good because picking the out-performers is largely a function of randomness.
2. You inherently accept the average market return.
3. Investing in an index can dramatically reduce your investment expenses.
4. The result is that you end up with the average market return, at a lower than average cost. You’ll be slightly ahead.

The research on investor performance is clear. The average mutual fund investor tends to have worse returns than the average mutual fund. Behavioral factors have a lot do with this. People tend to be emotional, and can often react in precisely the most incorrect way possible when markets are volatile. Fear often causes investors to sell investments when they are down. Performance chasing is another notable behavior.

Heard a lot about the latest mutual fund that is performing so well? That’s probably not the time to buy it, yet many are tempted.