By now, we should all know that no one gets wealthy investing their money in a saving account.
With inflation chewing away at your money, a savings account is the sure way to lose money in the long term.
So where should you invest your money if you have some extra money lying around?
I get asked this all the time.
If you are risk-averse, but also want to achieve a return greater than 2.5%, investing in low-cost index funds are probably your best choice.
I believe everyone should walk through their different investment options carefully before deciding on a strategy, but I suspect index funds will represent the best balance of returns, effort required, and
What Is an Index Fund?
An index fund is a specific type of mutual fund whose portfolio is constructed to match or track the components of a market index, such as the S&P 500. In general, index funds are generally described as investments that provide broad market exposure, low operating expenses and low portfolio turnover (buying and selling of stocks in the portfolio).
Why Choose an Index Fund?
A low-cost index fund is best for you when you can honestly say, “I have no idea which stock is better than another.” An index fund buys shares of every stock in the market in proportion to their market cap, and their whole job is just to mirror movements in the market. Buying a low-cost index fund is saying that you are betting on the broad, long-term prosperity of all US-traded companies.
Is this a good bet? History would say so. The compound annual growth rate of the S&P 500 from 1950 to 2016 was 11.27%. The last two years have looked less promising with a CAGR of 8.35%, but still very solid. The compound annual growth rate strongly depends on whether you start in a really terrible year (15-20%+ declines) or not, but over pretty much every long stretch of 20+ years you will see high single-digit or low double-digit returns.
Of course, past performance is no guarantee of future performance, but it is one of the strongest indicators an investor can use to get a rough range of what outcomes they might see.
The nice thing about index funds is they tend to be extremely low cost. Because the money manager’s job is just to mirror an index, they can keep costs below, often below .05% a year. That means you, the investor, get to keep as much of the gains as possible.
Index Funds are Long-Term
An index fund strategy is a long-term strategy, which means you ideally will have at least 10 years of runway to let the strategy do its work. Note that this does not mean if you plan to retire within 10 years that you can’t have index funds in your portfolio, but it does mean you may want to consider an allocation of your portfolio (i.e. less than 100%) that does not require you to sell chunks of your index funds every year to make ends meet.
Some retirees get by flagrantly defying this rule. It really has to do with when and whether you see a downturn – if you retire into a giant bull market, you’ll look at your returns and have no reason to believe that you need to have your money working in the strategy for 10+ years.
But if you happen to be the unlucky cohort that dumps your money in right before a downturn where you see real trouble if you were planning on selling chunks of your stocks every year. Fortunately, historical data shows you should still be just fine and generate respectable returns as this unlucky cohort, as long as you don’t pull the money out while it’s down.
Index fund dollars need to stay deployed while the market is relatively attractively priced and poised for recovery. That’s why you should plan to leave the money untouched for 10 years or more; it’s for the situation in which there’s a major downturn and you don’t want to have to sell undervalued stocks just to make ends meet.
Where and How to Trade
There are over half a dozen great discount online brokerage sites you can open an account with to start investing. They are generally all SIPC-insured, which means if for whatever reason the company folks (very unlikely) they have created a consortium whereby your assets will be protected and reimbursed up to $500k per type of account. My current favorite online brokerage is Robinhood. My second favorite is Charles Schwab.
Conclusion
The low-cost index fund strategy serves as an excellent benchmark for evaluating investment strategies and may be the best choice for you.
Similar posts you should read:
Index funds: The Easy Way to Invest and Financial Peace
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