How I Invest
Ben and I receive a lot of emails asking about our investments and what we recommend others invest in. Because I’m not an investment adviser, you can take my investing experiences with a grain of salt. However, I have spent a great deal of time researching and I’m confident in my cautions, yet consistent approach. For me, it’s not a game of picking winners or losers or risking money on hunches, rather, it’s playing the indexes and keeping individual stock purchases to a minimum.
I have stressed before the value of investing directly into an index, an idea that has been tested as of late. Buying into an index simply means your fund tracks the S&P 500 or Dow Jones Industrial Average, as two examples. When you purchase a fund that tracks an index like this, you are essentially buying a little bit of each stock representing the index, not literally, but it’s a good way to picture it. In my opinion, the main advantage of buying directly into an index like this is that you’re guaranteed, year after year, to get returns equally matching the index. You won’t see returns above or below the index, which is what many investors dislike about this boring approach. However, it’s nearly impossible to find a mutual fund that can consistently beat the index year after year, let alone find a mutual fund that can even match an index over its lifetime.
This approach to investing is very similar to a manager of a Major League Baseball team. Everyone knows (except Ben) that in baseball, numbers and stats are relied upon to make decisions. If a certain hitter has great career numbers versus a pitcher, he will likely get the start, regardless if he’s the best player for the position or not. Taking this same approach to investing, if an index fund year after year continues to beat most mutual funds, Exchange Traded Funds (ETFs), and other investments, why would you play anything else?
I like the S&P 500 index, and thus, most of our retirement money is invested in it. I invest in the index in two different ways; the first is through an employer sponsored retirement match program. Typically, most retirement funds will offer at least one index fund. The second way is by buying an ETF of the index in my Roth IRA account. Another advantage to these indexes is because they simply track an index, the day-to-day management of the funds is minimal, which means the fees associated with owning them are very low versus a mutual fund for example. This is significant because just a 1% yearly fee on a retirement account can reduce the earnings by 17% over a twenty year period (read more about the impact fees have on mutual and index funds here.)
Lastly, I do want to have a little fun and control over my investments, so I do buy individual stocks. However, to keep myself in check, I limit my overall portfolio of individual stocks to not exceed 10% of the entire fund. Overall, I’ve been OK at picking a few stocks. For example, I recently got lucky buying Sirius radio (SIRI) when they were close to bankruptcy and since my purchase, it has gone up tremendously. Having said that, I have made a few bad bets, primarily early in the financial crisis when I purchased a few bank stocks thinking they were steals, but I didn’t totally realize the severity of the economic crisis at the time. This is a perfect example of why keeping your individual stock picks to a minimum is beneficial, in the end, I’ve returned close to what the index has over a short period, but I’ve had a lot of fun picking, researching, and watching the stocks.
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Comments
Your right, ETF index funds are a great way to get into the market without minimums.
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*The* source for advice on simple, sound, index-based investing is the Bogleheads Investment Forum (http://www.bogleheads.org/forum/index.php). It is a great place to learn.
I like how you define how much you will invest in individual stocks, then stick to it. I too am a huge, huge proponent of KISS index investing, but I also realize how boring it can be! A small ‘kicker’ portion to one’s portfolio keeps your risk in check but also provides excitement and gives you something to talk about at the water cooler.
You mention that index funds tend to beat ETFs year after year, but many of them are the exact same thing; the only differences are the fact that the ETF trades like a stock instead of fund (and other small differences between the two). When I started buying Vanguard Total Stock Market Index, I didn’t have $3k free to meet the minimum investment for the index fund, so I bought the corresponding ETF instead.