How do you plan on improving your financial life?
No matter your financial goals, increasing your wealth is certainly on the top of that list. But striking it rich by stuffing cash under the mattress isn’t going to work.
Where then should you be putting those hard earned dollars, to make them work just as hard for you?
There are a myriad of ways to invest, from real estate to blockchains, commodities to collectibles. But, among the possible investments, there is one type of investment that I recommend more than anything else. Stocks. In specific, index funds.
What is an Index Fund?
An index fund is a collection of financial instruments, stocks and bonds, that is designed to mimic a financial market. Simply put, an index fund is just a tiny piece of an entire market.
These index funds come in the form of either mutual funds, or exchange traded funds.
One of the most popular index funds to be mentioned is the SPY ETF. This fund is composed of all the stocks held in the S&P 500. The S&P 500, as a refresher, is an index of 500 of the largest US companies (by market capitalization). This has several implications for investing, which help with your long-term wealth accumulation.
Diversification
One of the keys of investing for most people is to ensure they are diversified. While there may be some rare exceptions who have picked winning companies time and again, they are precisely that, the rare exceptions. When discussing your financial health, your dreams, your future, we don’t leave that to a lucky roll of the dice.
Index funds solve this dilemma, by allowing you to purchase a broader section of the market. Depending on the index fund chosen, you own a small piece of all the assets. In the above example with an S&P 500 index, you would own a piece of each of the 500 companies on the index. That means you own Tesla, Apple, Microsoft, Amazon, Johnson & Johnson, etc. This one investment lets you buy into technology, consumer goods, mining, oil and gas, and many other industries.
Diversification of this nature helps you stay away from any one industry. If a major event hits the oil and gas industry, much of your investment is stored elsewhere.
Picking a Winning Stock
A common rejection of the indexing idea is that picking the right stock, at the right time, and you will achieve far superior results. From a math standpoint, those people are absolutely correct. If you bought Amazon before it became the company it is today, your wealth would have grown exponentially. The same with Apple, or Netflix.
But, for every winner, there are a dozen other equally as spectacular failures.
How would you know that Netflix would become what it is today, when Blockbuster was the household name 20 years ago? Blockbuster certainly had the industry connections, they had the brand recognition, and they had the financial resources to pull off a streaming service. Would you have made the bet that a mail-order DVD rental company would become one of the most prominent media companies in 2021?
Index funds, on the other hand, hold a small piece of many assets. That means you would have been an investor in those early days. Along with holding assets in many other companies. Those wins would have been your wins. Those returns would be driving the returns in your portfolio.
Barriers to Entry
Index funds, particularly mutual funds, have one of the lowest barriers to entry. If you wanted to buy shares in the same 500 companies as in the S&P 500, you would need tens of thousands of dollars to invest.
This financial barrier has been somewhat reduced with some brokerages now offering fractional share ownership. But, the complexity of buying and managing the market weighting of 500 companies would be just as intimidating.
The complexity and the financial barriers are both solved by index funds. Now, anybody with a couple of dollars can invest in the entire market.
The Easiest Winner - Index Funds
Perhaps the most important reason why I recommend index funds for every investor is their simplicity. Sure, you gain some diversification advantages. And, you own a small piece of the winners. But those aren’t the main reason people don’t get investing right.
The main reason people make financial mistakes is the confusion. Too little, or too much information, and people become stuck. Paralyzed by the indecision, they often make the most costly decision of all, the cost of inaction. In these situations, you need less to do more with. Less complexity in your financial plans, and more investments driving your financial goals.
No Safety Deposit Box for your gold bricks. No warehouse for your barrels of oil. No trouble with the renting tenant. And no listing that precious painting for auction. Index funds are so easy, anyone can use them.
Buying into an index fund is easy. It’s simple. Implementing the right system automates all of this so you invest and keep investing without even thinking about it. You too, can use index funds to automate your path to financial independence.