Index investing for dummies, let’s dive in… If you save $300 every month and earn a 10% annual return, you’ll have a $1 million fortune after 45 years.
The first time someone explained to me how to invest in index funds, I barely understood a word. It was as if they were speaking a different language.
Today I thought it was time to write the post, and I wish I had learned this when I was younger.
We’ll go through exactly how this works step by step.
Just a quick warning, I’m not a financial advisor,
I have a passion for the stock market and investing, and these are just some of the real-life strategies that have worked for me.
Check also my latest post Financial independence and Market Cycle Psychology
Table of contents
- Is an index fund good for beginners?
- Understanding the game of index investing.
- Index investing where to begin
- Invest at the same time or dollar cost average
- ETF vs Index Funds
- How do I become an index investor?
- Index investing Types of Funds to choose
- TLDR
Is an index fund good for beginners?
Do you want to increase your wealth? People have been telling you lies about investing all your life.
For the longest time, I believed investing wasn’t for me because I wasn’t a professional and I didn’t have a lot of money and I thought I didn’t have a chance.
Also, every time I told my family about investing, they seemed so scared because they thought it was the riskiest thing in the world and not for normal people.
These lies are exactly what the experts want you to believe because they know that investing in index funds is extremely easy.
You do not need a lot of money to get started, the risk is quite low, and on average you will make more money in the long run.
The truth is that the average actively managed fund yields two percent less per year than the market in general.
This means that, on average, the pros do worse than the index funds, and even if they lose your money, they still charge you fees.
Understanding the game of index investing
I know when I first started investing, I felt like I was going to make so many mistakes, but once you understand this language, everything becomes much easier, and that’s what we are going to talk about in this part.
I have read about index funds in many books, so I think it’s time I explain what they are.
Let us take the S&P 500, for example.
This is a list of the 500 largest publicly traded companies in the U.S. by revenue, including Amazon, Google, Apple, and most recently Tesla.
If a company doesn’t perform well, there’s a risk that it’ll be removed from the list.
The idea of an index fund is to be a little sneaky because it allows you to invest in every single company on the list with just one click.
So when you invest in index funds, it means that even if some companies do poorly, it’ll be offset by the companies that do very well.
The average return of the S&P 500 over the last 10 years has been 10%.
The beauty of it is that no one has ever lost money.
if you bought and held an S&P 500 index fund for more than 20 years.
So if this is so bulletproof, why are people still buying individual stocks?
Well, I personally agree that some companies are currently working on great technologies for the future, but aren’t making much money right now. purely for the fun of it.
Index investing where to begin
Roth IRA, in the U.S., Stocks and Shares ISA in the United Kingdom.
TFSA in Canada, and Supers in Australia.
But what do all these mean?
Well, they’re accounts that allow you to make profits on your investments that you don’t have to pay taxes on, but they generally have limits because they’re just so powerful.
Make sure you use these accounts for your investments.
One way to do this is to invest the money in your account in index funds, and all the profits are yours because the government doesn’t retain a dime.
Invest at the same time or dollar cost average
One of my biggest questions, when I started, was whether to invest all my money at once or gradually
A lot of investors argue about that, so I’ll give you my opinion.
Investing all your money at once is certainly riskier.
However, if I’m investing in something that I know will go up over time, like an S&P 500 index fund, then there’s no point in waiting.
The longer you wait, the worse you’ll do on average.
However, if you don’t have the money, I couldn’t wait to save the money. I’d just invest what I can every month, and sometimes you buy when a stock is high, other times when it’s low.
But overall, it will balance out, and that’s called dollar cost averaging.
ETF vs Index Funds
If you sign up for a brokerage account, you will see that there are so-called ETFs.
These are very similar to index funds, and many people confuse them.
Both allow you to invest in a basket of stocks.
The easiest way to remember the difference is to keep in mind that ETF stands for Exchange Traded Fund.
In simple terms, it means that it can be traded on the stock market throughout the day, while an index fund can only be bought and sold at a price that is set at the end of each trading day.
You probably want to know which is better. If you’re starting out with little money, ETFs are on average the better choice because they’ve lower minimum investment amounts.
Many brokers don’t charge trading fees.
Not many people learn that at such a young age, it’s not taught in school.
The real secret ingredient to this millionaire formula is time.
And when you are younger, you have so much of it.
That’s because every year you add to your investments, interest rates grow at a rapid pace.
It’s a snowball effect.
Once you reach a certain tipping point, the interest you’re making is much more than the amount you’re investing on a monthly basis.
The sooner you get started, the better, as time will be on your side.
How do I become an index investor?
When talking about index funds, you always hear the S&P 500, which people just love.
As I mentioned, it’s the 500 largest publicly traded company in the U.S., but the great thing about it is that you do not have to be in the U.S. to invest in this fund.
I love the idea of owning a small portion of the largest companies in the US.
All you need to do now is to master the strategy.
So many people will teach you what to do, but they’ll not tell you how to do it.
The first thing you should really do is formulate your goals. Let’s say you want to become a millionaire.
How much would I actually have to invest per month to achieve that?
With these compound interest calculators, you can easily find yourself online.
So if you’re able to invest $250 per month with an annual return of eight percent, you’ll have over a million dollars in your account over 42 years.
The next thing we need to do is pick the brokerage website we’re using to set up our account and invest.
There are so many in the US like Charles Schwab, Fidelity, and Vanguard.
The main things to focus on are the expense ratio, which is how much they’re gonna charge you per year.
You obviously, wanna keep these as low as possible, Vanguard fees are very low, last time I checked.
it’s always good to remember that past performance doesn’t always mean future returns.
Index investing Types of Funds to choose
Bonds – are a type of contract that companies and governments sell when they need extra money.
When you invest in these bonds, they promise to pay you back in the future.
They are often considered fairly low-risk, but also fairly low-yield.
Therefore, the older you are, the more bonds you should have in your portfolio.
Balanced funds – The idea is that you choose the age at which you want to retire and they do the rest of the work for you and find the right mix of index funds.
but personally, I always prefer to invest manually.
Small, Medium, and large-cap –
Here you will find VFIAX, which tracks the S&P 500.
Vanguard’s selected funds they recommend.
Another good fund is VTSAX, an index fund for the entire stock market that includes over 3,586 different stocks.
This allows you to invest in the entire U.S. stock market.
there is also an ETF version with no minimum investment amount called VTI.
Then there are international stocks.
A pretty cool fund is the Emerging Markets, which invests in companies in China, Taiwan, India, and many other countries.
Sector-based – if you have a special interest in energy, healthcare, or real estate, you can invest in these sectors.
And there are many more options for sector investments in the ETF.
TLDR
Dividing an investment among many different funds is a good idea, but I personally like to invest most of my money in American companies.
about 70% in America, 20% in other countries, and 10% in some bonds.
I keep the bond portion fairly low because I don’t mind that little bit of extra risk because I’m only 43 years old and I’ve some time before I need to rebalance my portfolio to protect my investments.
This is a personal decision that depends on your risk tolerance.
The funds available vary from country to country, but the index they track is very similar.
It really is as easy as that.