What to Buy When Buying Stocks

A lot of people make a very nice living telling folks like you and me what stocks to buy, then taking a cut of our money. It’s a pretty old game, and it’s rigged in their favor. It’s so rigged, in fact, that the cut they take of our money can soak up as much as two-thirds of our long-term gains and they’re not even legally required to act in our financial best interest! But I have a secret, a trick to prevent those modern day snake oil salesmen from stealing the majority of your life’s savings. That secret? Index funds.

The dawn of the index fund

When we think of buying stocks we generally imagine a careful inspection of a company, gauging its long-term value, and then choosing to buy shares in that company with the hopes that they rise in value over time. When Apple released the iPod we might have thought, “Oh man, this company is going places, I had better buy in!”

For many years that’s how the stock buying world went around. You’d research some companies or, more likely, you’d pay someone to do it for you and then you’d buy shares based on someone’s research. The problem with that approach is that almost everyone who picked stocks for a living was absolutely terrible at it, but with the average person unaware of how to do it themselves it didn’t matter; people who managed stocks for a living always had a steady stream of customers!

That all changed in 1975 when a man named John “Jack” Bogle opened an investment company called Vanguard that allowed, for the first time, a casual investor to purchase something called an “index fund.” Unlike a traditional stock purchase, buying shares in an index fund is like buying little slivers of lots of different companies’ shares. What Bogle had figured out after twenty years of investing was the dirty little secret of the investment industry: almost all stock pickers were just guessing and they were pretty terrible at it. Instead he noticed that the entire market over time grew steadily. There were downturns (think of the 2008 economic crash) but there were upturns as well (pretty much all of the 1990s). Over time? Capitalism worked! A large grouping of stocks from different companies gained value over time as companies succeeded and expanded.

Bogle’s ah-ha moment

Having figured out most investors were simply better off buying this new type of investment, Bogle set out to bring the option to casual investors saving for retirement. The end result? He founded a group called the Vanguard Company with the goal of selling index funds to everyone.

Simply selling index funds wasn’t enough of an edge for Bogle. The costs for traditional mutual fund investments were hidden in the fees you paid to stockbrokers for managing your fund. With a human picking stocks (poorly) for customers fees had to be charged to make sure those salesmen could earn an income. Under Bogle’s new strategy? His company could passively manage funds without have a human picking them meaning a lot fewer fees and better returns.

Think of it! Now not only were the costs of owning mutual funds less because you didn’t have to pay a crook to pick your stocks for you but your returns were better because you were investing in large swaths of the market and letting capitalism do the heavy lifting for you. Lower costs and higher returns. It was an investor’s dream come true!

So what the hell IS an index fund?

Index funds don’t pick and choose stocks based on what’s hot or not because that’s impossible to predict. Instead they pick a pre-determined set of parameters and invest on those guidelines. Perhaps the most common set of rules for an index fund is following those established for determining the S&P 500. Indices that follow the S&P 500 purchase portions of stock from the companies included in the S&P 500 regardless of what’s happening in the market. The payout? Over nearly 100 years of data the annual rate of return for the S&P 500 is a whopping 10%!

To summarize: investing in an index is like buying lots of little pieces of many companies instead of big chunks of just a few. The historical data proves Bogle was right: your rate of return with this strategy is almost always better than paying a salesman a cut of your future earnings to do the work for you.

Buying index funds

If you want the investment option that offers you the lowest fees and the historical highest rates of return index funds are where it’s at. Buying them is easy. Almost all companies that sell mutual funds offer index options. If you have a workplace 401k, check your investment choices to see if you’ve selected index funds as a portion of your investments. If not, check to see which index funds are options and examine re-allocating your investment mix. Don’t forget: fees should be low. If your investments are charging more than .5% fees on your investments you’re overpaying compared to a solid index fund.

If you’re a private investor or mostly use your own Roth IRA and/or Traditional IRA for investment, you can pick from any index fund available. Jack Bogle’s own company, Vanguard, is still in business today and is one of the largest index investment companies in the market. You can find them on the web here. Always control your fees: if it’s over .5%, keep looking.

The big secret to never being taken advantage when buying stocks ever again? Don’t rely on a shady salesman to do it for you! For long-term investing index funds are the low-fee, high return option everyone should be able to access.

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