There are many different routes you can follow when it comes to investing. 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 on the stock market. This approach is adapted from the famous businessman Warren Buffet in his book “The Snowball.“
Mr. Buffet says,
“By investing periodically in the Index Fund, the know-no investor can actually outperform most investment professionals.”
So what you’re about to learn will make it possible for most Wall Street investors to outperform.
Table of Contents
What is an Index Fund?
The Index Fund (also commonly referred to as the Exchange-Traded Fund or the ETF) is a fund that has been structured to mirror or follow the returns of a market index such as the S&P 500 or the Dow Jones.
This is helpful because it can be difficult to determine which products to invest in. Not to mention that putting large amounts of your net worth in just a couple of securities is very dangerous.
So instead of investing in a single stock, you’re purchasing a portfolio share that monitors a couple hundred of them.
Nowadays a few ETFs to choose from, and as stated above, this will greatly reduce your risk as they are diversified through multiple classes of securities. We will take a look at which ETFs to choose in a second.
Where To Invest Most of Your Money
The explanation Warren Buffet chooses Index Funds instead of choosing individual securities to invest in is that it is incredibly difficult (if not impossible) to consistently find particular companies that will outperform the stock market’s performance over the long run.
Buffet was so optimistic that he put a popular Million Dollar Bet with some of the top hedge fund managers that they couldn’t outperform the market over a 10-year term. Buffet has just won his winnings.
Diversification 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
Take, for example, 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 considered to have very low volatility, which ensures that their share prices do not fluctuate a ton day-to-day. This means you’re not supposed to wake up a week from now and expect your money to double.
However, over time your net worth will grow steadily and reliably (the historical return of the stock market is around 7-9% yearly). Suppose you’re going to start investing in Index Funds today and you’ve transferred some money to your Acorns account
You purchase a few shares of the above ETF and sit back to watch your money grow. The clock reaches four o’clock and the stock market shuts. Your total return for the day is…-.09%. Nice.
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 presume you’ve been saving your capital for the last 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 saved $10,000 at this point last year, you would have gained an additional $1,571 by doing nothing.
And that doesn’t even mention distributions that would have been paying out all year round! $1,571 is about 175 hours of work on a standard minimum wage.
So by opting to invest your money instead of investing cash, you’ve actually received an extra 175 hours of income.
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 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.
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 Round-Up Index Funds:
- The Index Fund is a portfolio which tracks a wide range of investments (usually a variety 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.
Our Favorite Investment Platforms
If you’re not the most patient when it comes to staying loyal to your investment goals, Acorns is for you.
Acorns will automatically round up every purchase you make up the nearest dollar and invest the difference for you.
They invest your money into an Index Fund (again using the same strategy as above). It’s the modern-day equivalent of saving your loose change in a jar and we definitely recommend it!
Open your Acorns account and get a $5 referral bonus!
Improvement can handle your retirement account (IRA) at a fraction of the cost of traditional institutions.
An IRA uses a strategy similar to what we talked about above. The biggest difference is that it is geared towards retirement and you will have to pay tax on any withdrawals you make.
Betterment gives you real-time access to your money and return via their app and makes it really easy to set up automatic deposits.
Titan is more than just a regular return on their money to investors.
Their platform allows you to participate in actively managed hedge funds at a fraction of the cost that most companies charge.
Titan does not use the same approach as above and instead their model operates like this: their algorithm analyzes the highest-performing 5% of hedge funds, from which it picks the top 20 shares of those funds and invests the capital in those firms.
They also provide you with the research they’ve done on each company that they invest in so you know WHY your money is going there. Titan’s all-time IRR (Internal Rate of Return) is 10% vs. 8.2% of the market during the same period.
The strategy you learned in this article is taught by Warren Buffet and practiced by the majority of major investment firms and we hope that this helps make it easier for you to get started on your investment journey!
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