Investing in the stock market should be one of the cornerstones of your financial freedom strategy. A solid stock portfolio can significantly speed your progress toward independence. There are also plenty of ways to get into the game and you probably already partake in one or more of these options. 401K, 403B, Roth/Traditional IRA and taxable brokerage accounts are some of the more popular investment vehicles. Even if you don’t personally delve into the market, your employer may have a pension fund that harnesses the power of the stock market. The market can be a beautiful money maker especially if you add in the additional bonus of compounding interest on reinvested dividends… Ka-Ching!!!
However, truth be told, the market can be confusing and downright scary at times. For all the positive movement the stock market can provide, it can also really knock you for a loop if you are not careful. We have all heard stories of people losing life savings from investing in Enron or people who invested too heavily in dotcoms when that bubble burst in 2000. These are real risks that influence real dollars. It is irresponsible to jump into the market with both feet if you don’t know what you are doing.
So now that you are ready to just stuff your cash in your mattress rather than invest in the market, let me tell you about index fund investing.
An index fund is a type of mutual fund or ETF (electronically traded fund)with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). In this example, your index fund would invest in all 500 companies or components of the S&P 500. Basically, your one stop shop for investing in a certain market index or even the total stock market itself!
True, index fund investing isn’t the flashiest way to invest. It is not getting in on a big IPO or riding a crypto wave. You probably are not going to brag to your buddies about how much money you made overnight with your portfolio or see any “Wolf of Wall Street” type movies coming out about index fund investing. That is the point. Index fund investing is a slow and steady process. This portfolio is built to be a grower NOT a shower.
Legendary investor Warren Buffett believes in index fund investing and has put his money where his mouth is. In 2007, Buffett once famously bet 1 million dollars that an index fund would outperform a collection of actively managed hedge funds over a 10 year period. He won. Buffett along with another titan of business, Mark Cuban, have been quoted as giving index fund investing a thumbs up when it comes to passive investing in the market.
Here is what makes these particular funds more attractive than Jennifer Love Hewitt in her heyday.
1: Diversification Your investment will be spread across an entire index. That is immediate diversification. Just investing in the S&P 500 index will literally put you into 500 different companies!
2: Low Cost- Index funds famously have some of the lowest cost ratios among mutual funds. Also, since you will be spread over so many companies, there is little need to manage the buying and selling of individual stocks. Actively managing a portfolio is one of the biggest killers of your stock wealth over time.
3: Foreign Investing- An S&P 500 index fund basically has foreign investing built into it. Most of the companies that comprise an S&P 500 fund are huge and have international reach to their products and brands. So you get built-in international exposure without the volatility of jumping into foreign market.
4: Winners and Losers- Investing in index funds will inevitably yield some winners and some losers. The beauty is that your losers can only go down to zero at worst but your winners… the sky is the limit! Just imagine that you began investing in 2013, when Facebook began being included in the S&P, you would have gotten that stock at a great price compared to what it is trading at today. You would also have had some losers in that time but I am sure that the winners are still winning today and the losers have already fizzled out of your portfolio.
5: Simple and Passive- The goal of index fund investing is to buy and hold for a long period of time. There won’t be a ton of trading going on, except for the occasional re-balancing. As simple as set it and forget it. The true beauty of the index fund.
So there you have it. Index funds can be a powerful tool in your investment portfolio. Simple and passive, they are a great way to ease into the market.
For more information on the subject, I recommend you read the book “The Simple Path to Wealth” by JL Collins. It is a great read by an author who has put the power of index fund investing to work for him throughout his investing career.