When it comes to investing, there are many different routes you can take. You can invest your money into practically any vessel that has the capacity to increase in value or produce dividends. Unfortunately, many of these routes can be out of reach for most people as they require either immense capital or immense knowledge. There is one method, however, that has been proven over and over as one of the best strategies for investing.
Today, we’re going to share with you what is widely regarded as the easiest and most effective way to make money in the stock market. This method comes from the legendary investor Warren Buffet in his biography “The Snowball”. Mr. Buffet states, “By periodically investing in an Index Fund the know-nothing investor can actually outperform most investment professionals.” So what you’re about to learn will allow you to outperform most Wall Street investors.
What is an Index Fund?
An Index Fund (also commonly known as an Exchange-Traded Fund or ETF) is a portfolio that has been constructed to match or track the results of a market index, such as the S&P 500 or the Dow Jones. This is beneficial because it can be tough to determine which stocks to invest in. Not to mention that putting large portions of your net worth into only a handful of stocks is very risky.
So instead of investing in one single stock, you’re buying a share of a portfolio that tracks a few hundred of them. There are quite a few ETFs to choose from and as mentioned this will dramatically reduce your risk because they are diversified across multiple different asset classes. We will take a look at which ETFs to choose in a second.
Where To Invest Most of Your Money
The reason that Warren Buffet prefers Index Funds instead of finding specific stocks to invest in is because it is incredibly hard (if not impossible) to consistently find specific stocks that will outperform the return of the stock market over the long run.
Buffet felt so confident in this fact that he placed a famous Million Dollar Bet with some of the biggest hedge fund managers that they could not outperform the market over a 10 year period. Buffet recently collected his winnings.
Even more importantly, Index Funds, apart from historically outperforming the return of most individual stocks, will help you to diversify your investments. If you put your life savings into one stock and that stock performs poorly, you’re out of luck. However, if you put your life savings into a fund that tracks 50 different stocks and one performs poorly then you still have 49 others that could perform well.
“Don’t put all your eggs in one basket in case you drop the basket”. “It’s better to be safe than sorry”. These quotes are cliches but, like most cliches, there is some truth to them. With investing, it is much more important to focus on not losing money than to go for home runs. One missed homerun can set you back years.
Investing in an Index Fund Over 5 years – Example
As an example, let’s take a look at the Vanguard S&P 500 Index which tracks the return of the S&P 500, or the 500 most influential companies in the United States. Index Funds are known for having very low volatility, meaning that their share price does not fluctuate a lot day-to-day. This means that you shouldn’t wake up a week from now and expect your money to have doubled. However, over time your net worth will grow steadily and reliably (the historical return of the stock market is around 7-9% yearly).
NOTE: These screenshots were taken from Robinhood, who we recommend if you’re looking for a great platform to start investing.
Suppose you wanted to start investing in Index Funds today and you transferred some money into your Robinhood account. You buy a few shares of the above ETF and sit back to watch your money start to grow. The clock hits 4pm and the stock market closes. Your total return for the day is…-.09%. Not super exciting.
BUT suppose you had started 1 month ago. After the entire month had passed you would’ve earned 1.25%. Granted, you’re not rich yet but you’ve actually earned more in 1 month than most savings accounts will earn in an entire year.
Now let’s say that you’ve had your money invested for the past year. Well over this past year you’d be looking at a hefty return of 15.71%! That’s not too shabby at all! If you had invested $10,000 at this time last year you’d have earned an extra $1,571 by doing nothing. And that doesn’t even include dividends that would’ve been paid out throughout the year!
$1,571 is roughly 175 hours of work at a standard minimum wage job. So by choosing to invest your money instead of saving it, you’ve already earned an additionally 175 hours worth of wages.
It keeps getting sweeter! If you had started invested 5 years ago in the same Fund you would have gotten an 83% return over 5 years! This would’ve turned a $10,000 investment into $18,300 (not including dividends which are paid each quarter)! This is the power of slow, steady compounding growth.
To quote Warren Buffet, “Someone is sitting in the shade today because someone planted a tree a long time ago.” The best time to start invest was 20 years ago, the second-best time is right now.
Obviously, the previous scenario sounds pretty ideal. An 83% return over 5 years? Who would say no?
That being said, the stock market does not offer a guaranteed return and the history of the stock market does not indicate future performance. These screenshots were pulled was during a period of growth for the U.S. Economy. There is always the possibility of losing money in the short-term, which is why we recommend keeping your money invested for the long run. The historical return of the stock market over any given year is around 8% and is what you should expect to earn in the long run.
To Sum Up Index Funds:
- An Index Fund is a portfolio that tracks a wide range of investments (usually a range of stocks)
- They are a safe, reliable place to let your money grow and produce dividends over time.
- We (along with Warren Buffet) recommend keeping the majority of your money here.
Remember, all the research in the world is useless without action! Get started today and your future self will thank you.