I’m proud to feature our first guest post! Michael L. is the creator of Super Millennial. He teaches people how to evaluate their financial situation, simplify money management & learn how to automate their investments to reach their financial goals. Subscribe for his personal finance “Keys To Success” PDF and blog updates HERE.
Note from FP: I was inspired to have Michael share this post after talking with several friends who insisted that individual stock picking was their path to wealth. I’m a diehard index investor and fully believe that any investor should keep their investing life as simple as possible. As Michael explains, you should be lazy when it comes to investing. I couldn’t agree more.
Enjoy what Super Millennial has to share with us!
Simplicity, it’s what we all want to achieve in every area of our life. That’s why we have Netflix instead of cable (plus it’s cheaper), endless two day Amazon Prime deliveries, or Postmates making your favorite restaurant deliverable….This post will show you how simple it is to do even in your financial life!
Hopefully by now you understand how important it is to invest in the stock market to grow your money over time. As the saying goes, “No one ever got rich from a savings account”, especially nowadays with less than one percent interest. But the next question many people ask is where do I invest? Should you buy stocks, bonds, mutual funds, gold or tons of other options? This question alone shows why a lot of people avoid the market entirely, it’s complicated!
Honestly you don’t have to be a genius, wall street guru, or financial analyst to be a smart investor at any age. All you need to do is focus on investing in low cost index funds in your 401K, Roth IRA, or brokerage accounts INSTEAD of picking individual stocks. Make it a habit over time and your money will be diversified, have low management fees, and track the market, which historically over time has averaged roughly 8% returns over the past century, slightly better than your >.1% savings account.
While everyone wants to be Gordon Gekko or Jordan Belfort as a stock picking guru/day trader, the chances of success are very small for the average investor. Picking stocks is expensive, takes time to research the companies, and can be a lot riskier than index funds. By picking stocks individually you:
- Have a lot of your “eggs” in one basket. Example: If the company has a bad earnings call or something affects the stock your investment will be directly related.
- Live and die by one company. This happens a lot when people invest their 401K or employee stock into their employer, there may be benefits but it can also cloud your judgement as you’re already emotionally invested to the company.
- Have to stay actively engaged & research the stock. Who wants to read earnings calls, understand a balance sheet & learn their price to earnings (P/E) ratio? Just typing that made me bored…
Is index investing as sexy as buying Netflix seven years ago and making 300% gains? Or Amazon or Apple a few years ago? The simple answer is NO, but unless you have a few hours a week to study each stock in your portfolio don’t bother with individual stocks until you have a decent amount of wealth built up. Instead of stock picking focus on index funds!
What’s an index fund?
As the name implies, index funds follow a specific index (like the S&P 500 or Dow Jones). Historically these have returned ~8-9% returns annually. While you may get more in some years from individual stock picking you may also lose a lot more on down years. Index funds try to keep performance consistent and reliable.
Investopedia defines it as “A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.”
Basically it means that index funds are a single fund that invests in HUNDREDS of individual stocks or bonds. Let’s look at an example to simplify;
VTI (the stock ticker symbol) is known as the Vanguard Total US Stock Market Index. One of the biggest funds available; it currently holds 3,682 stocks worth $458 BILLION.
Here are the 10 biggest stocks in the fund:
All are very big companies and would take thousands of dollars to invest in each company. Instead with an index fund you get to be partially invested in all of these big 10 companies and thousands of others instead of buying each stock individually. This is an example of an index STOCK fund, meaning no bonds are in these funds. An example of a bond fund would be BND; a fund that has 7,911 bonds that make the fund worth $171 billion.
Now you’ve understood the “hard” part about the original question…Where do I invest my money?
Next up is understanding how to be LAZY with your portfolio to keep the theme of simplicity going.
In fact you want to make your strategy as lazy as possible, which is known as a LAZY portfolio. This is the only time I’m asking you to be lazy in life but it’s a strategy I have implemented and don’t have much stress when it comes to contributing to my portfolio. “Lazy Portfolios” are meant for you to be able to invest in a few funds and be fully diversified with just a few clicks.
Make sure you are comfortable with your asset allocation and figure out which percentage of stocks/bonds will match your risk tolerance. Here is an example of a TWO fund portfolio which is great if you’re just starting out & think investing is hard!
LAZY PORTFOLIO Example
- Low management fees (which means you keep more $$$)
- Low minimum investment (1 share of each)
- ***As of 8/23/16 VTI is trading at $112/share & BND is trading at $84/share
- Passively Managed
- Diversified (between the two funds you have 3,682 stocks in VTI & 7,911 bonds in BND
- Doesn’t have any international exposure
This portfolio is good for beginning investors who don’t have a ton of capital and want to keep it as simple as possible. It can also be a great place to start and build upon. If you’d like international exposure as well, look at VXUS, which is a total international stock fund that is invested in 6,041 different international stocks. By choosing two or three funds you have an extremely low cost, diversified portfolio. Does this seem much easier than studying and buying each stock, or even the top ten in the funds? It should!
Most people don’t invest until it’s too late because it seems tedious, they don’t understand how to, or where to invest & because it requires constant upkeep (who wants that?). Lazy portfolios are the exact opposite & make your life simple. Next time you decide to procrastinate on making your first investment read this post to remember how SIMPLE this is…Lazy Portfolios will let you set it & forget it!
And that’s the goal, to keep our lives simple and easy.