There is no such thing as a free lunch.
If there is a good deal to be had, someone has beaten you to it.
You don’t get something for nothing.
They are all clichés, but they are worthy of mention. However you phrase it, investing in the stock market can be a frustrating endeavor or refreshingly simple and straightforward. Picking individual stocks for your portfolio is frustrating because you are competing against millions of other investors out there, all armed with the same public information as you, scouring the globe to find companies that will grow their earnings just a little faster and a little longer than the competition.
If that task seems overwhelming to you, there is an easier way. Try keeping it simple by investing in a portfolio of low-cost index funds that own all of the publicly traded companies – the good, the bad, and everything in between.
You should take what the market gives you, and leave it at that. This investment philosophy, abhorred by the stock-picking crowd of Wall Street, is growing in popularity by individual investors. Thinking of changing over to a portfolio of low-cost index funds? Let’s look at some of the benefits in store for you.
You put performance in its place. When building a common stock portfolio, how can you tell whether your portfolio is performing up to par? When do you switch to something better, and when do you stick with what you have? When you own the market through index funds, you know you are getting your fair share of the stock market’s returns, and can be satisfied with that.
You embrace an investing philosophy for a lifetime. Investors of all sizes, especially large endowments, foundations, and pension funds, fail miserably at staying committed to a portfolio. This conundrum is spelled out in an investment policy statement that requires these institutional accounts to replace underperforming fund managers with a new “5-star” performer.
This musical-chairs approach to investing destroys a portfolio’s long-term returns. It is a no-brainer choosing the top mutual funds based on past performance. It is a far bigger challenge to determine when to sell an underperformer — a dilemma those who follow my advice never have to worry about.
You keep your costs under control. According to the Investment Company Institute, the average expense ratio of equity mutual funds in 2013 was 0.77 percent, a hefty number compared to the annual costs of broad market index funds that charge less than 0.25 percent.
For recent college graduates who are contributing the maximum in their workplace 401(k) plan, this seemingly small extra cost adds up to hundreds of thousands of dollars missing from their retirement account by age 65.
You can focus on what matters most in building wealth. Accumulating a portfolio large enough to sustain you during your retirement years can be a daunting challenge. Wall Street offers complicated and irrelevant things like Monte Carlo simulations, Morningstar Style Boxes, and Standard Deviations to “help you reach your goals.” You are better off ignoring it all and directing your attention to the one number that counts — saving. If already retired, you should attend to the flipside of saving — spending. The luxury of building a retirement account around index funds is it provides you 100 percent confidence that you are doing the right thing with your portfolio, an assurance that makes it easier to commit to saving.
You can focus on what matters most in life. I can’t think of anything that is more distracting than paying attention to daily portfolio swings tied to the stock market. We need to focus all our essential creativity on our companies and industries to stay one step ahead in an extremely competitive business climate. I love the challenge, and I know you do, too.
The journey of building wealth can appear intimidating and insurmountable. It doesn’t have to be that way. When we unclutter one part of our life, we enrich another.