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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