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
Pros
- 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
Cons
- 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.
Kevin is an attorney and the blogger behind Financial Panther, a blog about personal finance, travel hacking, and side hustling using the sharing economy. He paid off $87,000 worth of student loans in just 2.5 years by choosing not to live like a big shot lawyer. Kevin is also passionate about earning money using the sharing economy and you can see exactly how he makes five figures every year in his side hustle reports. Feel free to send Kevin a message here.
Index investing is great for people who don’t want to do any work into investing and are happy with the market return. Stock picking requires a lot more work but it can provide substantially higher returns, not to mention it makes you aware of what you are buying or investing in. As an example, S&P 500 have had a return of merely 5 or 6% for the past year whereas my individual stock portfolio of 40 or so stocks have returned nearly 20% for the same period. Yes, it takes a lot of work to pick stocks and then monitor them, but again I enjoy doing the work as I find learning about businesses very interesting and overtime I would only get better at it.
Do you plan to do individual stock picking forever or is it just a fun thing you do? In other words, do you pick stocks with retirement money or just fun money?
It’s not a fun money, it’s the money I have earned and saved over the course of 20 some years and invested over time in individual dividend paying stocks so that it can provide income when I leave my job which I did recently.
I look at managing a stock portfolio as running a business, if you want it to do well, you have to put work into it. There is just no easy money at least not the one that would stick around.
Would I do individual stock picking forever? Forever is a long time, but I do plan to continue doing this as long as I can. I am only 43, so I could do this for many more years before I get tired and completely retire and may be then I switch over to Index Funds. I do invest in Index Funds but only in my traditional retirement accounts where individual stocks are allowed.
Correction: I do invest in Index Funds but only in my traditional retirement accounts where individual stocks are NOT allowed. Besides, the very long term horizon of those accounts make Index investing more appealing.
Completely agree! In the future I’ll be adding individual stocks with money not associated with retirement hoping for greater returns. For beginner – intermediate I think index is always the way to go since the research is minimal (just find funds w/low fees), set it, and forget it. The other downside w/individual stocks is how expensive it is to get a diversified portfolio compared to index.
As long as you’re doing your hw I love it, way to go w/the 20% returns that super impressive! Do you index for your 401K/IRA?
Thanks, yes, I index in my 401k and it has been that way for a long time, it’s like being on an auto-pilot and I don’t worry about it much.
My taxable brokerage account is where I keep my individual stock portfolio. Starting out, it is expensive but once the portfolio is up and running, can take few years, the turnover rate can be quite low, especially if you are buying good dividend paying stocks. I hardly ever sell any of my stocks, so most of my transactions are to buy shares in existing or new stocks that are at or below fair value. It is very satisfying to see the portfolio grow and generate dependable income.
Set and forget typically works better when your investments appreciate in value. When they don’t, you tend you “remember” and look at your investments a lot more often even if you know your strategy is to leave them alone – to let em ride up and down.
To improve your ability to stick to your system through major ups and downs, you may consider implementing a stop-loss rule to exit your investments in case a major bear market develops. A stop loss protects profits and principal during downtrends, but it can subject you to whipsaws where you stop out at/near the bottom only to watch the recovery. If this happens, you need some rule to get back in.
Resting on the belief that markets always go up over the “long run” can be dangerous for your investing results. One big downtrend and your financial situation can take a major hit.
I’ve got a friend who’s big on stock picking vs indexing and I’ve got the perfect post now to show him more reasons why I prefer indexing. Great post and I completely agree!
Definitely all about keeping it simply!
Thanks I appreciate it! As fun as it can be to pick a good stock and cash out at the right time it’s way to time consuming & risky for me. I dedicate all 401K/Roth to index …set it and forget it. Only thing I like being lazy at in life hah
Great post!
“Honestly you don’t have to be a genius, wall street guru, or financial analyst to be a smart investor at any age.” I think this is such an important point to drive home. Many people are afraid to start investing because they don’t think they know enough, but just STARTING to invest is the most important thing they can do. We invest in mostly index funds with Vanguard. Easy peasy (and lazy), but it works.
That’s great! Really it doesn’t have to be hard. You really only need enough return to get you to your goals. So why take on added risk or use up more time for additional return if you don’t need it. If your starting young, you don’t need 20% a year to get there!
And when you’re young, the thing that really matters is savings rate. You need to accumulate money first before rate of return really matters a ton. So make it easy so you can accumulate money.
Thanks I appreciate it! I know that’s why I was so delayed in investing, I thought it was to hard to understand and didn’t want to lose money! Vanguard index funds make it simple for sure and you can always add stocks on in the future.
I understand the “easy peasy (and lazy)” approach, but investing without a protective stop loss in case the markets roll over like 2000, 2008 or godforbid the Great Depression where markets fell -80% and didn’t make new highs for 20 years just makes me too nervous.
Investing without some sort of exit plan for each investment can be a dangerous game, especially in an environment of a sluggish economy and low yields (meaning, you won’t be able to recoup your losses fast enough to maintain your standard of living).
Working as a 23yr old at Bear Stearns in 2008 during it’s collapse struck a chord with me. Since that time, I declared that losing a ton or all of my money in a bear market (or in any scenario) was never going to happen to me. Without a protective stop-loss on each investment, you’re susceptible to catastrophic losses whether you realize it or not.
I’m a boring stock picker. I do have a 3 index funds and some mutual funds but I mainly stick to dividend paying stocks. If you stick to dividend paying stocks you almost can’t go wrong.
Do you have your dividend stocks in taxable accounts?
It’s just like Warren Buffett’s bet. A portfolio of 90% invested in s&p and 10% invested in bonds will beat out any hedge fund / activist investing portfolio. I believe in it, which is exactly how my 401k is structured!
Buffett’s bet is awesome, he’s always talking about index funds and he’s worth 60+ Billion, you think people would listen to him more lol. My 401K is the same, very asset heavy since I’m not planning on touching for another 30 years!
Thanks for reading