I want to be the first to congratulate you — if you’re reading this, you’re likely interested in beginning your investing journey. Or perhaps you’ve already started and just want to know what the heck I’m talking about. It’s all good in either scenario. The stock market empowers anyone to brighten their financial future.
But there’s a right way and a wrong way to doing things. Avoiding reckless decisions and excessive risk is essential for those just dipping their toes in the water. The good news is that there are investment tools that can help you position yourself for long-term success, especially for those just starting. I present to you: index funds.
How do index funds work?
Index funds are baskets of different stocks or bonds traded under a single ticker. It’s like someone investing in a portfolio of stocks and then breaking up ownership of it into shares that you can buy and sell. In other words, one share of an index fund gives you a tiny sliver of every stock in that fund.
There are numerous benefits to index funds. First, they help diversify your investments easily. Instead of deciding on a long list of individual stocks to buy, an index fund gives you ownership of many stocks under one ticker symbol. Turn-key diversification!
Additionally, there are many index funds out there, and you can find funds that speak to just about any investment style. Do you just want an index fund that behaves like the broader stock market? A fund like the Vanguard S&P 500 ETF (VOO -3.51%) has you covered. There are index funds that focus on dividends or growth, while others are devoted to specific sectors like technology. The options are virtually endless.
Don’t underestimate them
A common misconception about index funds is that investors will generate poor returns. Hedge funds and other professionals that actively trade will surely outperform a fund that mirrors the plain-old stock market, right?
Ironically, the truth is more like the opposite of that statement. Famous investor Warren Buffett once wagered (and won) that a simple S&P 500 index fund would outperform several hedge funds over ten years.
Remember, the S&P 500 has averaged roughly 10% annual returns over the long term, which is plenty to build wealth over a long enough holding period. Heck, you’ll double your money every seven years or so!
Investors can build a portfolio of diversified funds, just like they can with stocks. Some index funds built around the S&P 500 can be a great starting point for most investors, and then you can surround it with funds aimed at your specific investing goals, whether that’s growth or dividend-focused.
Index funds are an excellent tool for beginners, giving them the upside of long-term market returns while protecting them from the unnecessary risks of picking your stocks from scratch. It can pay to keep it simple.