Now that you’ve started saving your hard earned cash, it’s time to progress to the second level of your personal finance revolution: INVESTING.
For most people, investing is limited to their 2% annual interest savings account. While low-interest savings accounts are better than nothing, there are better options, the stock market being the obvious place to start.
For many people, the stock market is a daunting place associated with crashes and severe losses. However, in reality, it’s a pretty safe place to invest and grow your money.
Indeed, if you look at the historical chart of the S&P 500, a patient long-term buy and hold investor almost can’t lose.
As you can see, the S&P 500 is on an upward trend since the 1980s. We notice two major crashes – in 2000 and 2007 – but the market has since recovered and more than doubled in value. The lesson to be learned is that the stock market is cyclical but ultimately keeps going up. Sitting on the sidelines means missing out on gains.
So how can you join the party?
There are two main strategies for investing in stocks: Active and passive investing.
Active Investing: The Art of Picking Stocks
This is the specialty of professional investors (hedge funds): They spend their days analyzing companies to find undervalued stocks whose prices will skyrocket and make them rich. They have the pressure of having to pick the right stocks and timing the market to buy low and sell high.
This is a very complex undertaking and most people don’t have the time or insider knowledge to make it worthwhile (=profitable).
Also, despite their expertise and sophisticated researching tools, the majority of investment professionals fail to consistently beat the market. That’s right, over the course of an investment lifetime, the majority of those wolf of Wall Street hotshots depicted in Hollywood flicks actually under-perform the market!
Lastly, investment professionals command substantial fees that eat into the gains you make. Not only that, but they also require you pay them hefty management fees even when they lose you money!
For these reasons, I discourage beginners from trying to beat the market through individual stock picking. Rather, they should adopt a safer, passive investment strategy.
Passive Investing: Index Funds
Warren Buffet, the “Oracle of Omaha”, famously said that the average investor’s best strategy for consistent, low-risk gains is to invest in index funds. Who am I to contradict his advice?
According to Investopedia, an Index Fund is “a type of mutual fund with a portfolio constructed to match of track the components of a financial market index, such as the S&P 500. An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. These funds follow their benchmark index no matter the state of the markets“.
Simply put, an index fund is composed of a basket of stocks that tracks the performance of a certain market or index. An S&P 500 index fund will include the companies that compose this market: Since you invest in all the companies of that market, the under-performance of one or a few stocks will not hinder the overall performance of the index. Your gains will be the average performance of the entire market. Pretty cool right?
The most popular index fund tracks the major American exchanges such as the S&P 500, Dow Jones and NYSE. Incredibly, these passive investment vehicles consistently outperform active investing fund managers. Such is their consistent ability to generate returns that they are causing a crisis in the active investment world and even large asset management firms are having a hard time finding new clients.
In addition to the big market indexes, there are myriads of other index funds out there tracking just about every market imaginable: There are index funds tracking the performance of large and small-cap companies, foreign stocks, dividend-only stocks, oil and precious minerals companies, commodities (such as food and water), bonds, banks, and much more.
This means that you can hedge your risks by diversifying your index fund portfolio to avoid putting all of your eggs in the same basket.
HOW TO GET STARTED
Simply create an account, provide your tax number and wire some funds from your bank account.
Then, search for the index fund you wish to purchase and buy your desired amount of shares.
You’ve done it! You are now a stock market investor!
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Disclaimer: This is not financial advice. Perform due diligence before investing in any asset. Be aware that every investment has a significant risk factor that can lead you to losing part of all of your initial investment.