When it comes to investing, the first thing people think of is the stock market, and rightly so because over the long term, the S&P 500 (an index made up of the 500 largest public companies) has provided on average an 8% return annually, adjusted for inflation. This is the average over a 90+ year period! If you’re looking to save and grow your money for retirement, or just life in general, this is likely going to be a major part of the strategy. So what do you need to know?
First things first, if your company offers a 401(k), hopefully you’re investing there, especially if the company matches, which is effectively free money, and the 401(k) itself is one of few tax-advantaged retirement accounts you have available. If you don’t have that option, there are other options like a traditional IRA or Roth IRA. I won’t go into detail with those, (check out this Investopedia entry for more info) but keep reading because a lot of what I’m about to say will still apply
In 401(k), you’re typically given some options of buckets (funds) to invest in. Each bucket has a slightly different investment profile, usually depending on how far you are from retirement age. The farther you are from retirement, the more “aggressive” the investment strategy, which just means that the bucket has a higher percentage of money in stocks vs less risky assets like bonds.
But in any given month or year, the stock market as a whole can be doing extraordinarily well, or it can tank in dramatic fashion.
Now even with all the ups and downs, over the long term the market returns 8% on average, but if you’re very close to retirement age, you’d likely prefer not taking too much risk in having a huge chunk of your retirement savings in an asset that could collapse in value and not have enough time to recover before you start withdrawing after age 59 ½ (the age at which you’re able to begin withdrawing from this retirement account without paying penalties).
But if you’re a long way out from retirement, you’ll likely want to choose a bucket that is more invested in stocks than bonds so you can maximize your return, and if there are any dips in the market, you’ll have much more time to recover and continue to grow.
And when you select that bucket, what you’re really buying into is either a mutual fund or an index fund.
What is a mutual fund and/or an index fund?
I’ll describe it as an example: Instead of you trying to go out and buy hundreds of different stocks, you can invest into this one fund, which pools together your money and a bunch of other peoples’ money, then, in turn, invests in hundreds of different stocks. So what happens is you get broad exposure to many stocks, which the fancy word for that is diversification, and your returns should approximate the average return of a particular market, and hopefully do a little better.
What if I want to invest outside of a 401(k)?
Which brings me to my second major point, if you’re looking to invest in the stock market OUTSIDE of a 401(k), you’ve got a lot more options. However, like in a 401(k), you can invest in these types of funds on your own.
There are many more options out there offered by investment firms like Fidelity, Vanguard, Charles Schwab, to name a few. And each of them offer a bunch of different funds that may target certain industries, company sizes, countries, you name it, there’s probably a fund for it.
Any way you look at it, when it comes to investing in the stock market, the best bet for most people, is going to be an index fund. Why?
Stock market can yield good rewards – although there is some risk associated with investing, you can reduce that risk
Investing in the stock market in general has some risk associated with it, but when you invest in just one company, the risk is substantially higher.
If that one company doesn’t perform well, you’re out of luck. Of course, it can also perform very well and you come out in good shape, but the more companies you invest in, the less reliant you are on any one company to perform well in order to get a return, which makes your overall investment strategy less risky.
In an index fund, your minimizing that risk because instead of being invested in one stock, or 5 stocks, you’re effectively invested in hundreds!
Quick note on index funds vs actively managed funds
Last note on index funds, I ordinarily recommend that over a mutual fund because mutual funds (ones that are “actively managed”) typically have some management fee or expense ratio ranging anywhere from 0.5 – 2.5%, which can take away from your earnings.
Reason for that is because mutual funds are actively managed, meaning there is a team of people strategizing and make decisions on entering and exiting stock positions on a regular basis, so there are frequent transactions, all with the hope that they are able to outperform the market. So, the management fee pays for that.
However, it’s been shown time and time again that actively managed funds often don’t outperform an index fund, which is minimally managed, far fewer transactions, designed purely to trend with the overall market performance, and is ultimately less expense, higher return, for you.
Now if you really wanted to, you could take the risk and invest in specific companies yourself. The reward can be greater, but so can the losses.
**I’ll be doing plenty of videos & articles on that topic, as there’s quite a bit more to unpack.
Here are your three main take-aways:
- The stock market as a whole carries a degree of risk, but also good returns over the long term
- If you want to invest in stocks, index funds will generally be the best option for most people that gives you the best reward for the risk you take
- If you want to invest in individual stocks, you certainly can; if you want to learn more about that, make sure to subscribe to this channel because I’ll be posting videos on exactly that subject in the future
Thanks for reading – stay tuned for more articles and make sure to visit my YouTube channel for videos on these subjects!