Index Funds – Your #1 Option For Your Retirement Account – Part 5
Over the last six weeks, we have covered a ton when it comes to a successful retirement. You know how compounding interest works, how much you need, and what types of accounts there are. Now it comes down to choosing what to invest in. This is where many people have different opinions. We’re going to ignore all opinions though and go strictly off historical facts.
Like most things keeping it simple and consistent will lead to success. Keeping it simple in the world of retirement investments means using low-cost index funds. For 99% of people in the world, this is the one and the only thing they need to invest in. Index funds aren’t fancy, they aren’t exciting, but they’ll get a solid return.
When most people think about investing they focus on single stocks. I would highly advise against this (speaking from personal experience here). If you want to learn why I wouldn’t recommend this read my article: 4 Reasons You Shouldn’t Trade Stocks
Now, before we jump into the exciting world of index funds let’s just hear what Warren Buffet has to say about them.
So a man worth almost $90 billion dollars and referred to as one of the greatest investors of our time just told you the secret. If you didn’t watch the video (which you should, it’s 2 minutes) he stated that an investment of $10,000 in 1942 would be worth over $53 million now. That is such an increase it’s hard to even comprehend. How did this happen though?
Remember that chart from the first couple weeks? Here it is again.
The two names I want to focus on here is Consistent Claire and Late Laurie. Both of these people had the same % return and were contributing the same amount. The only difference being that Claire started 30 years earlier.
Claire’s situation is set up to reflect what would happen if you invested consistently in an index fund. She made a 7% return. Which is what historically index funds like the S&P 500 (I’ll explain what is it in a minute), have returned to investors. This could be you, nothing here is overestimated. In fact, I may have watered down the numbers a little bit. So what is an index fund and why should you invest in it?
What Is An Index Fund?
When you hear someone talking about index funds the first thing that should come to your mind is the stock market as a whole. Essentially this is what it is. They are a large collection of different publicly traded companies compiled into one stock. The two most popular index funds are the Dow Jones Industrial Average, and the S&P 500. These two funds are a collection of the weighted averages of 30 and 500 companies respectively. These companies include the like of Amazon, Apple, Netflix, and many others. If you read any form of news then you hear about them, it’s unavoidable.
While these two are the most popular they are just a small drop in the bucket for all the options out there. Most index funds are just a collection of U.S. stocks, but you can buy one for just small companies (Russell 2000), or even just bonds (Vanguard Total Bond Index Fund).
The main point here to know is that index funds are diversified.
Why An Index Fund?
As mentioned above index funds have the ability to be spread out over multiple industries. This allows them to better gauge the actually economic landscape and lowers your risk as an investor. If you want to invest your money and leave it then you need to diversify. An index fund does all the work for you.
One of the big advantages of an index fund is they are cheap relative to your other options. Yes, of course, you must pay a fee for a certain fund but just know they are the cheapest option. Fees usually range from .1-.5% annually compared to the 2-7% for a mutual fund.
These fees can be even higher if your portfolio is professionally managed. The worst part about this is actively managed accounts rarely beat the return of an index fund. In these situations, you lose twice. Potentially costing yourself hundreds of thousands of dollars. Again, these are real numbers.
Wrapping It Up
If you can keep it simple and get a solid return why wouldn’t you? Most people find the topic of money boring and that is fine. But just because you think something is boring doesn’t mean it’s not important. If you could stick your money in one place and come back in 50 years and have over a million dollars why wouldn’t you? I have one more table for you. Stick with me, this one is exciting.
As I stated earlier the S&P 500 represents the market or index funds. From this table, you can see that the win rate, or positive to negative, on a daily basis is even at 54% to 46%. What you will then notice is that as you stretch the time frame out the positive return percentage grows. Slowly but surely it creeps up until it hits 100% positive over a 20-year time span. If you didn’t notice already this table covers almost 90 years of stock market return history! This includes both world wars, a great depression and recession, and countless other bad times. Even with everything, there is still a positive return.
This chart should drive home the fact that you want to be Consistent Claire. If you invest over 20+ years in an index fund you will have a positive return. Your money is making money and the beautiful effects of compounding interest take over.
If this doesn’t get you excited I don’t know what will! Let me just recap everything in a simple list:
- Buy an index fund
- Continue to make contributions consistently
- Wait 30 years
- Wake up someday to a huge nest egg
Lastly, I purposely didn’t include a list of my top index funds because the people over at Balance already did a great job with this. If you want to see that list click here.
If you happened to miss any of the previous week’s articles in the retirement series then check them out below.