Overview: Steer clear of fancy, complicated, or risky investment options. Be happy with market returns with low investment fees. Investing shouldn’t be exciting, it should be boring. Plain old index funds fit the bill.
You’ve written down your investing goals, you’ve put your financial house in order, you’ve decided to start investing a certain percentage, and you’ve found the different accounts you have access to for investing. Now it’s time to think about what things you should invest in inside your 401(k) and Roth IRA.
Let me also add that investing is highly personal, and “there are many roads to Dallas.” There are, however, several keys to smart investments that you should look out for. Deviate from those keys, and you will most likely be paying high fees for too much uncompensated risk.
The keys: Your investments should be simple to invest in, easy to understand, low cost, tax efficient, and diversified. The best thing that fits that bill for me is: Index Funds.
Taylor Larimore, of Boglehead fame, has read over 250 books on investing in his 90+ years, and has reached a similar conclusion. Index funds are lower cost mutual funds that follow an index, like the S&P 500, or the US Bond market. There are hundreds of index funds to choose from. The beauty of cap weighted index funds is that they are easy for brokerage firms to manage, so they are cheap to run and therefore charge low fees for you to own. They also don’t get greedy by buying up too much of a hot stock. They merely mirror the market.
Investors get burned when they pile into the next hot tech stock (Snap?) and then it implodes. And Crypto makes hot tech stocks look harmless! By simply taking the market returns and not getting too greedy, index funds help investors diversify across the entire market. The opposite of index funds might be analogous to buying individual stocks. That is very risky business, especially for a retirement portfolio. The disaster stories of people losing their entire retirement when Enron tanked was a classic case of uncompensated risk, where too much of their holdings were tied up in one company. Had those same retirees bought VTSAX instead of Enron, they would have held nearly the entire US stock market in one fund. VTSAX holds 3,575 stocks, where Enron would be a very small percentage of the total holding, avoiding such massive losses.
Everyone wishes they had bought AMZN at $19. I’d love to go back to 1984 and buy that fruit company called AAPL. The trouble is, we don’t know which stocks will be the next superstars. I take a compensated risk by owning all of them. When we drive into the Home Depot parking lot, I tell my oldest daughter that she owns part of it. Same with McDonald’s. Index funds don’t try to beat the market, but simply provide the market returns.
There is beauty in simplicity. Owning four to six passively managed index funds gives you heaps of diversification, at a low cost, that you can simply buy and hold. Allow this pilot to tell you to put your investments on autopilot. You can send your money in each month and not have to worry about which stock is hot and which is not. You don’t need an advisor to send you “hot stock picks” – you can simply delete those emails because they aren’t necessary.
But if index funds are so great, why is there so much talk about stocks and hot picks on all the investment programs, from CNBC to radio shows? I think it all boils down to hype, trying to fill time and sell advertising. The lack of hype over index funds shows me just how solid they really are. Bill Bernstein and others have often said that the best financial advice you can get, is to tune out the financial media. TV shows, radio programs, and countless pages in the print and digital media inundate us with news about this stock or that bond, this company or that government. Tune it out. It’s all noise. All that is needed is a few good index funds, but that won’t fill hours and hours of programming time or pages and pages of print. What’s the fun in that? What’s more to discuss? Exactly. There isn’t much, so tune it out and stay the course.