There’s one core principle that comes up again and again in the lives of those that get rich and stay rich. One that drives everything else: Wealthy people spend their lives accumulating Assets.
Want wealth? Get Assets.
An asset is something you own that either grows in value or produces value.
Growing in value means you bought it for $$ and you can sell it later for $$$$. Producing value means it pays you a stream of money over time. For an asset to be an asset, it has to do one, or the other, or both.
Assets come in many forms, each with their own strengths and weaknesses. There’s no one that’s the best, only ones that are the best for you.
This article will be about investing in the stock market. More specifically, it’s about how to invest over the long term in a way that’s simple, effective, and doesn’t require constant attention or insider knowledge.
Sound good to you? Then read on.
Why The Stock Market
The stock market is a vast exchange where you can buy small portions of companies.
In truth, there are multiple “markets” and much more is bought and sold than stocks.
Because of the rise of the internet, there are now plenty of brokerage firms you can log into and buy stocks from any location in the world. You don’t have to go anywhere or be anywhere to participate. Many of the other good investing options aren’t like that. If you had a rental property and you decide to move across the country, you’re either looking at managing the property from afar, hiring someone to manage it, or sell it. Same thing with running a small business – many of them aren’t easy to transplant.
Investing in the stock market skips all of those issues.
You can also start with smaller funds upfront. A discount brokerage might require a minimum of $1000 to open the account. After that you can add however much or little your budget allows for over time.
You can do all this on your laptop or your smart phone.
Why Mutual Funds
Picking stocks that will grow require two things: knowledge and attention. You need to know something about the company and the market, and after you make the purchase you need to keep an eye on things because inevitably it won’t go exactly the way you expected.
The best and brightest people in the world are out there everyday trying to determine what combination of stocks are going to make the most money. They get expensive educations, and it’s their full time job – often more than a full time job.
Their goal is to beat the market. That’s not something you do once. Winning that fight today doesn’t mean you skip that fight tomorrow. Or next week. It’s something that needs constant attention year over year.
That’s why mutual funds were created. You hand over your money to these smart people and you get a piece of their portfolio. You select the fund, they worry about buying and selling individual stocks.
Why Index Funds
Mutual Funds aren’t without their drawbacks.
First, mutual funds require less attention than buying stocks on your own, but not zero attention. The fund manager’s goal is to beat the market. The stock market will always go up and down like the tides of the ocean. You’re paying someone to make sure you’re above the water more than you’re below it.
The problem is, most funds can’t seem to do this consistently over the long term.
Some manage to stay up for a while, but historically most spend at least some of their time below the market. Over a long time horizon, most fund managers simply cannot consistently beat the market. There’s simply too many variables to account for them all.
Plus the fund manager takes a fee from your investment account whether they grow your investment or not.
You do need to pay some attention to what the fund is doing to make sure it’s moving in a direction that you want. The fee you pay may look like a small percentage, but considering the long term implications, many don’t think that it’s worth it.
Enter The Index Fund.
Index funds are similar to mutual funds in that they are a collection of stocks. The main difference is that they are essentially run by computers (and thus charge tiny fees) and their goal is to simply match the market rather than beat it. An “Index” is a sample of an industry, a sector, or even the whole market.
You might hear people talk about Exchange Traded Funds (ETFs), you can functionally think of these as identical to an Index Fund. The ocean still goes up and down. But now you just ride along knowing that – over the long term – the trend is up.
The result is you contribute to a simple, reliable investment that always grows over time and requires next to zero attention on your part. The index will reflect any short or medium term dips in the market – but it will also reflect the recovery and growth in the market. Computers automatically make the necessary adjustments. Zoom in and you’ll see fluctuations up and down. Zoom out, and you’ll see long term growth overall.
“Risky” or “Secure”
Buy and Hold strategies don’t depend on getting any single hot stock, but rather a combination that smooths out the risk associated from any individual stock (also called “Hedging”).
“Risky” purchases are ones where the price can swing upwards or downwards depending on the performance of the company and the economy as a whole. They can increase and decrease in value.
“Secure” purchases are ones that stay mostly the same. They grow at a slow (but dependable) amount. A common secure purchase is a Government Bond, they don’t pay much, but they always pay.
Your portfolio is ideally made up of a combination of both. If you’re looking at a long time span (and you’ve got the nerves to deal with the times when prices drop and things look bleak) you want more “risky” stocks. If you can’t handle much risk, or you’re simply close to the age where you might want to start cashing out, you want more “secure”.
Think on timelines. Longer time = Less Secure (more to gain). Shorter time = More Secure (less to lose).
When indexing, you can do this by picking as few as three funds. Many experts recommend picking an index that tracks the American Stock Market, an index tracking the International Stock Markets, and an index that tracks the Bond Market.
You can shuffle between the three to match your current risk tolerance. There’s even ‘Life Cycle Funds’ that do this automatically for you (that is, you buy one fund and they do all that balancing work for you).
Whichever way you go, this requires a little bit of maintenance on your part maybe once or twice a year.
For additional fees, you can work with a Robo Advisor service (a low fee human broker that helps set you up and maintain your index strategy). This is for those who want the same low maintenance strategy but still want an experienced set of eyes to look things over and answer questions.
Tax Advantaged Accounts
It’s worth pointing out that you can purchase Index Funds through your IRA. IRA’s opens the door to a longer conversation – but essentially they are accounts that incentivize you to invest for the long term by reducing the taxes you have to pay to the IRS.
Or put another way, you get to keep more of the money that grows in this account. Maxing out these accounts is a smart move.
Who Indexing Is For
Index Investing appeals to those who want to expend minimal effort in managing their investment portfolio. Once things are setup and contributions are being made, there’s very little to “do”. The portfolio is consistent, regardless if you are working with a very large or a very small amount to invest.
Or put another way, there’s no reason to pay a lot of attention to your investments unless you like paying a lot of attention.
If you’ve got a busy family life and a thriving business and you have minimal amounts of mental bandwidth to go around – Indexing is perfect for you.
You can focus your energies in other areas – such as building a business, career capital, or marketable skills. I.E. you can spend your time making more money to invest into more assets.
The investments will take care of itself and you can spend your time and attention on whatever you might want to spend it on.