Turn your investment into a HUGE nest egg in the long run! This passive fund will help you do just that. [Wednesdays: The Independent Investor]
Miles Everson’s Business Builder Daily speaks to the heart of what great marketers, business leaders, and other professionals need to succeed in advertising, communications, managing their investments, career strategy, and more.
A Note from Miles Everson:
Happy mid-week!
We’re excited to share with you another investing tip.
Every Wednesday, we publish articles about great investment strategies with hopes to help you get on the path towards true financial freedom.
Today, we’ll talk about one of the commonly-used passive investing strategies.
Keep reading to know more about this type of fund and how you can properly use it to maximize your wealth and invest in the stock market.
Miles Everson
CEO, MBO Partners
Chairman of the Advisory Board, The I Institute
The Independent Investor
In a past “The Independent Investor” article, we talked about active investing and passive investing.
There, we explained that investors shouldn’t debate on which of the two is better because the type of investing they choose must depend on their spending habits and lifestyle.
For example: If you simply want to build the core of your portfolio and get the average returns of the market, you should choose passive investing.
On the other hand, if you want to try to beat the market and get higher-than-average returns, active investing is for you.
Today, we’ll focus on a subtopic of passive investing that is commonly-used by many investors. We’re referring to…
Index fund investing!
Photo from Capital.com
An index fund is a type of mutual fund or exchange-traded fund (ETF) with a portfolio constructed to match or track the components of a financial market index, such as the Standard & Poor’s 500 Index (S&P 500).
These funds follow their benchmark index regardless of the state of the markets and are generally considered ideal core portfolio holdings for retirement accounts and 401(k) accounts.
In fact, Berkshire Hathaway CEO Warren Buffett recommends index funds as a “haven for savings for the later years of life.” According to him, it makes more sense for an average investor to buy all of the S&P 500 companies at the low cost offered by index funds.
How an Index Fund Works
“Indexing” is a form of passive fund management. Here, a fund manager builds a portfolio whose holdings mirror the securities of a particular index instead of actively stock picking. The idea is by mimicking the profile of the index—the entire stock market or a broad segment of it—the fund will match the index’s performance as well.
Here are some of the most popular indexes in the U.S.:
- S&P 500
- Wilshire 5000 Total Market Index
- MSCI EAFE Index
- Bloomberg US Aggregate Bond Index
- Nasdaq Composite Index
- Dow Jones Industrial Average (DJIA)
Portfolios of index funds only change substantially when their benchmark indexes change. For instance: If a fund is following a certain weighted index, its manager may periodically rebalance the percentage of various securities to reflect the weight of their presence in the benchmark.
Simply said, weighting is done to balance out the influence of any single holding in an index fund or portfolio.
Why should you invest in index funds?
Index funds provide investors with an easy and effective way to build wealth. By simply matching your portfolio with the impressive performance of the financial markets over time, you can turn your investment into a huge nest egg in the long run!
Here are some reasons why many investors find index funds beneficial:
- Index funds minimize the time you spend in researching individual stocks. Instead, you rely on an index that includes the stocks you want to invest in.
- Index funds let you invest with less risks. Most indexes have dozens or even hundreds of stocks and other investments. This diversification leaves you less likely to suffer big losses if something bad happens to one or two companies in the index.
- Index funds are available for a wide variety of investments. You can buy stock index funds and bond index funds. You can also buy more focused index funds that drill down into certain parts of the financial market.
- Index funds help you stick to your investment plan. These funds let you invest month after month and ignore short-term financial ups and downs. As a result, you become more confident that you’ll share in the long-term growth of the market.
Among the great investment minds, the late John Bogle spoke about the secret that enabled millionaires to become millionaires: They focus on their jobs, and they invest in passive funds.
He also talked strongly about the benefits of passive investing over active investing, saying:
“It is indeed inevitable that a passive market strategy will, under all circumstances, past and future alike, outperform the combined result of all active strategies in the aggregate.”
Allow us to share with you an interesting story related to index funds…
In 2007, Buffett made a wager against another firm. He bet that hedge funds, which are aggressively active investors, could not outperform a single index fund composed of 500 of the biggest US companies.
The bet was USD 1 million dollars, which will be donated to the favorite charity of the winner.
Ten years later (2017), Buffett won the bet. On average, the hedge funds only made 2.2% per year. That’s obviously not a great return.
Meanwhile, the simple, passive fund made 7.1% on average every year in that same period. This return showed that Buffett’s words reflected his bet:
“Consistently buy an S&P 500 low-cost index fund… I think it’s the thing that makes the most sense practically all the time. The trick is not to pick the right company. The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently.”
What does this tell you?
To run a successful passive investing strategy, you need to only buy a fund that buys the biggest 500 firms. Through this, you get the average returns of the stock market. Additionally, there is less risk to any stock because your investment is spread over those companies.
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Most financial experts agree that index funds are great investments for long-term investors. They are low-cost options for obtaining a well-diversified portfolio that passively tracks an index.
So, if you’re planning to invest in index funds, compare different indexes first to make sure you’re tracking the best one for your goals and at the lowest cost.
After all, security selection can be difficult and time-consuming. Good passive investing focuses on choosing just the right passive funds for each asset class.
We hope you learned a lot from today’s topic!
Take note: The amount of index funds you buy is simply the amount each asset class requires to fit your investment strategy.
“The index fund offers the ultimate in character—the broadest possible diversification, the lowest possible cost, the longest time horizon, and the highest possible tax efficiency.”
– John Bogle, Founder and former Chief Executive of The Vanguard Group
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
About The Dynamic Marketing Communiqué’s
“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
LITERALLY.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
Every Wednesday, we’ll publish investing tips and insights in accordance with the practices of some of the world’s greatest investors.
We make certain that these articles help you identify and separate the best companies from the worst, and develop your investing prowess in the long run.
Our goal?
To help you get on that path towards the greatest value creation in investing.
Hope you’ve found this week’s insights interesting and helpful.
Stay tuned for next Wednesday’s “The Independent Investor!”
Cheers,
Kyle Yu
Head of Marketing
Valens Dynamic Marketing Capabilities
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