I’ll be honest and say that investing in the stock market has always been intimidating and mystifying. Yet, when companies offer 401ks those are investment accounts! I’ve felt held back by my ignorance and that I’ve been leaving money on the table for too long. So I started reading some books on the subject and this is what they both had to say.
Before I go further the books are “The Little Book of Common Sense Investing” by John C. Bogle and “The Elements of Investing” by Burton Malkiel and Charles Ellis. These books are written by the founders of Vanguard and the head investors of other companies.
Both books echo the same thing: Low to no-cost index funds are the best long-term investment. They also go on to say that a mixture of index funds bonds is also really important since when the market goes down, bonds go up, and vice versa.
No clever strategies about diversifying, no betting big on a FAANG or someone else. No faith whatsoever in investors. That last bit is ironic considering the authors. They do fully admit how the book is there to make me money, but their company is there to make them money.
Why Low-cost Index Funds
Index funds are built around the idea of owning a significant portion of the entire stock market in one fund. Another way to put it is they own the entire market, so investing in it is like investing in the economy as a whole.
Almost all investment advice you’ll see will tell you to create a diverse portfolio, and the author’s stance is there isn’t anything more diverse than the entire market.
Now, they go on to explain that if you look over time the performance of other funds, investors, etc. none of them out-perform indexes like the S&P 500. They might beat it temporarily but will eventually lag behind. The reason here is that the market itself is ultimately a representation of the economy, so when one part booms another slows. The more targeted funds or investments try to pick the booms, but over time they always come back to the balance representing the economy.
The low-cost bit deserves some attention. Funds come with costs. These costs are what investment managers charge to administer the fund for you. The reason you want to pay attention to the cost is that just like funds can earn you compounding interest, the costs compound as well. You may think that a 2% cost is not huge, but over time it adds up to tens or hundreds of thousands of dollars in their pocket and not yours.
Another way to look at this approach as a whole is that investing in low-cost index funds is investing in the health of the economy, and the returns go to either you or the costs of the fund. By choosing low-cost funds the rewards of a growing economy go to you.
Compounding and Rebalancing
On these points, the books differ a bit in their approach. Compounding is the idea that you put money in your index fund and walk away. The money it earns is re-invested into the same fund which accelerates its growth. Of course, if things to bad, the money goes with it.
Rebalancing, on the other hand, is when you pick a ratio of index funds to bonds. Let’s say the ratio you choose is 50/50. That means 50% of your investment is split between index funds and bonds. Periodically you go and look at your portfolio and if the amount of money you hold in each half isn’t equal, you sell and buy until it is 50/50 again. This is the most conservative way to win in the long-term. Both books consider letting the money compound or rebalance as great ways to go, but one favors compounding and the other rebalancing.
Ok, there is the old adage of buying low and sell high. Unfortunately from what I’ve seen people do the opposite. When the market turns south people begin to sell off their bad investments, when they should buy them instead. Similarly, as stocks climb people think that’s the best time to buy (FAANG or Crypto anyone?).
Dollar-cost averaging is a fancy way of saying that you ignore the current price and just periodically put money into your investments. By doing this periodically you’re creating a long-term average of a good deal when you purchase instead of getting swept up into momentary poor judgment. This makes sense to me as I don’t want to really watch the market for the best moment, or pile a bunch of money to throw in at once.
Whats Next For Me
Well, I’m in the process now of adjusting my portfolio to match what the head investors and founder of Vanguard suggest. I’ve been searching through the various index funds offered where I invest and I’m looking at the costs. I’m picking a ratio of bonds to index funds and going on from there.