Lets say that you are aware of the stock market, you understand what the purpose of the stock market is, and you agree that passive investments is the best option for your lifestyle. You realize that you need to be investing your money to increase your passive income and to diversify your earning strategy but you may not know what to invest in. There’s tons of stocks, bonds, options, other stuff that I am not even aware of, and nothing there really makes sense to you. I am no expert in finances, and I am especially not an expert in investing in the stock market, but I do understand diversifying risk. I also understand that I am plenty dumb, and if Warren Buffet says something about investing, we should listen.
A news story that has been making the rounds lately is about how Warren Buffet bet a hedge fund manager that an S&P 500 Index Fund would outperform hedge funds over a 10 year period. For those not in the know, a hedge fund is the investment strategy that some people try to sell to the super rich to make them even more super rich. An index fund, however, is a lot of stocks picked from the market, paid for by a lot of people who buy in together, and each get a share of that group fund. As the market itself increases, the fund is going to increase as well.
The beauty and success of the index fund is based on two things: Lower fees and lower risk.
When you’re talking about handing your money over to people to invest on your behalf, you’re talking to people who are going to actively search for stocks and bonds to put your money into. They will do the research, make the purchases, and sell before it loses money. The idea is that the person (most likely an AI now) will know best what to do with your money and take a little bit off the top from each move, regardless of the success of that decision, to pay for their services.
The issue with these fees being charged is that it’s a flat percentage of the amount they put into the market and if someone is actively managing your money, the fees will be pretty high. The more fees that you are charged, the less your account can grow because your ability to gain compound interest is reduced. I won’t list any fees or percentages here, because they are dependent on who is charging them, but understand that if someone is going to charge you to actively manage your account, they’re going to be higher than an index fund.
An index fund, opposed to an actively managed one, doesn’t require someone to make moves and make changes constantly. You buy shares of the fund, which is comprised of shares of the market; a wide group of shares. The index fund requires less activity, and thus can be provided to you at an expense ratio of 0.04%. Do you think any person would offer to manage your money for that little? Probably not.
The other advantage of an index fund is that you’re buying into a wider array of stocks. You don’t have to pick the right ones every time because you are buying a bunch of them. You’re not picking between Apple or Microsoft, because you’re buying both of them, as well as Pepsi and Coke. You’re not betting on which one is going to go up higher, you’re betting on the market going up. And over the course of 10, 20, 30 years or more, the market basically only goes up. The S&P has gone up from $113.61 to $2749 from 1980 to today. Sure, there were periods of time, sometimes years at a time, where it went down. But overall, the market goes up.
If you were picking individual stocks, you would instead by trying your best to see what company is going to do the best over a period of time. That’s MUCH harder to do than just picking a big group of stocks.
The Average Investor
The average investor, someone who works full time and kind of just wants to retire someday, spends a lot of time with family and friends whenever they can, and doesn’t have the knowledge or the time to watch the market like a hawk could benefit from passive investments like this. You’re basically making a one time purchase and sitting back for 10 years for it to mature. That’s the whole point of going with an investment firm in the first place! To sit back and let your money make you money.
Of course, there are people who will be drawn to making investment decisions for themselves, to which I would say “Get after it, feller!”, but this post isn’t for that person. That person is already interested in the stock market, and making moves is probably their jam. But if you’re someone who is just hoping to have something to retire on, or have something that requires a small commitment of time but still earns you money, an index fund is a hard option to beat. That’s why it’s the only recommendation from That Finance Feller.