After I got out of debt (it took me two years), I worked on increasing my savings. This was important for me, because I quit my day job and really wanted a big safety net in the form of savings.
So I increased my savings, but I realized that even with the best savings accounts, I was not making any money when you adjust for inflation â€” meaning, the interest I was paying in inflation was basically keeping me even with inflation. I was treading water with my savings interest.
So I switched to investing, and taught myself as much as I could. I learned about Warren Buffet and value investing, talked to investors who taught me the basics â€¦ and then realized I was wasting my time.
Hereâ€™s why I was wasting my time learning everything I could about investing:
- The easiest way to invest, and the one I do now, is with index funds. These are basically a whole bunch of stocks (or bonds) that are automatically managed, so you donâ€™t have to pick stocks and thereâ€™s no fund manager taking his fees off the top.
- Most professional fund managers donâ€™t beat the market (especially after you subtract their fees). I mean, basically no one does, and even the few who do are probably not better than the rest, just luckier, because statistically there will always be some people who beat the market, some who lose, and a bunch who do about the same as the market on the whole. That means fund managers arenâ€™t worth their fees, because you could just index the entire market and be the same as them, and since youâ€™re not paying them fees, you might beat them.
- If you want to pick stocks yourself, to beat the market, you basically have to make it a full-time job. You have to do a ton of research, and know more than most professional fund managers. Thatâ€™s not going to happen. Professional managers are well informed, hiring many full-time researchers (and contracting other firms to do research). If you think youâ€™re going to beat the pros, youâ€™re fooling yourself. And even if you do, is it worth an extra 1-2% earnings to basically spend most of your time doing research?
The bottom line is, you can spend zero time researching stocks and make as much as the pros, by using index funds. They have very low fees (if you choose the right ones, see below), they donâ€™t take any of your time, and they do as well as the market, which is pretty good.
Now, Iâ€™m not an investing expert, so please do your own research into index funds and donâ€™t just take my word for it. But Iâ€™ve spent a lot of time figuring this out for myself, and these are my conclusions.
Which Index Funds to Choose
Let me start by saying that there are no guarantees, and I donâ€™t have all the answers. That said, youâ€™ll probably want some recommendations, or at least know what funds Iâ€™ve picked.
The key criteria for me are:
- The funds have to index a broad swath of the market â€” not just a handful of well-picked stocks, but pretty much all of it. This way, if a handful of stocks donâ€™t do well, youâ€™re still pretty safe.
- The funds have to be very low fee. The fact is, if thereâ€™s even a 2% fee from a fund, youâ€™ll probably not do as well as the market, because with a 2% fee, you have to pick stocks that do 2% better than the market. Thatâ€™s hard to do. I like Vanguard index funds because theyâ€™re basically the industry leader in low-cost index funds (the whole company was founded to create these type of funds, from what I understand).
- You canâ€™t just index one market. For example, if you only have a fund that indexes the U.S. stock market, what happens if it crashes? You lose. So you spread out your risk by indexing the U.S. market, and the international stock market â€¦ and also U.S. bonds. If one of those doesnâ€™t do well, at least one of the others will. This is called diversification, and it keeps you safer, and from what Iâ€™ve read itâ€™s probably the smartest thing you can do with your investments.
- Ideally, it would be retirement-protected, so you can take advantage of retirement tax advantages. That means putting it in a 401(k)-type fund, for example (in the U.S.), so you donâ€™t pay taxes on it until you withdraw the money. That means the taxes you would have paid are available for investing and earning money for you.
OK, with those criteria, what have I chosen?
I set up an account at Vanguard.com (no, I donâ€™t get paid by them), set up a SEP-IRA (thatâ€™s one type of retirement investing account for individual investors), and invested in three index funds:
- Total U.S. Stock Market Index Fund. (60%)
- Total International Stock Market Index Fund. (20%)
- Total U.S. Bond Market Index Fund. (20%)
I have a monthly transfer from my bank account to Vanguard, and have Vanguard set up to automatically purchase these funds in this ratio â€” so if the monthly transfer is, say, $1,000 â€¦ I have Vanguard buy $600 of the first fund, and $200 of the other two funds.
So far, this is working very well for me. I don’t spend any time researching funds anymore, I have everything automated, my investments are diversified very well, I’m not wasting money on fund managers’ fees, and my investments have made a good return over the long term (much more than a savings account). To me, this is a win on all fronts, and I recommend this type of investing to everyone I know (as a friend, not as an expert of course!).