Avoid Stock Picking Heartache: An Index Fund Refresher
Apr 12, 2020
Do you think that now might be a good time to start investing for the first time? I think so. It’s as good a time as any.
If you are new to investing, I want this to be the first blog post you read, because it’s going to save you a whole heap of heartache in the long run. And that is a promise.
I’ve seen a noticeable jump in the amount of people using my Sharesies and Hatch links, which would indicate that a lot of new investors are jumping into the market. But if you think that you need to start choosing which specific company you want to invest in, to be blunt, you WILL fail and I thought I would burst your bubble about your stock-picking prowess, or lack of, early on in this blog.
You don’t have to pick Stocks
I’m not going to try to sell you a course for $9.95, fear not! Instead, let me introduce you to the concept of an INDEX FUND. When I realised that in order to become an investor I didn’t have to learn how to pick stocks and up and coming companies it was like the clouds had parted and the sun had finally come out and I hope to do the same for you.
John C. Bogle created the first index fund and it contained the best 500 companies in the US stock market. All of them were in this fund in proportion to their size. So when you are listening to the news, if the S&P 500 rises on that particular day, your index fund rises, if it falls, your fund falls. An index fund simply follows the direction of the share market. Luckily for us, New Zealand has an equivalent fund that follows our top 50 companies.
Professional investors initially thought Mr Bogle’s idea was dumb, after all, an index fund follows the average and who wants to be just average? These guys and gals thought they had the skills to pick the top companies (despite research to the contrary) and they thrived on the excitement of it. They also liked to charge investors handsomely for their advice which gouged out the returns their customers were getting. Index funds were dirt cheap in comparison because there was no stock-picking involved, no costly trading and few people were required to run them.
It’s a boring, yet effective strategy and it’s for people who want to invest in a total market, instead of speculating on which companies to buy. As an investor you don’t DO anything, instead the companies in the fund do all the work for you, going about their day to day businesses providing jobs, providing products and services and providing a return to their investors. You are not JUST buying units in an index fund, you are buying a stake in an exciting range of companies. You simply buy on a regular basis, over a long period of time and it’s low cost, extremely diversified and there is no need to buy and sell and continuously trade. Surprisingly simple and in my mind, that’s what investing should be.
I want to tell you about The Bet.
Warren Buffett is possibly/probably the world's best investor and at various times the richest man in the world as well. He proposed a bet where he would invest $320,000 US in an index fund and a hedge fund manager invested the same by actively picking stocks. The winner would get $1,000,000. The Bet began Jan 1st 2008.
Buffett said he was doing this “to publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” maybe.”
Year one was terrible for the index fund and the hedge funds were way up but as the ten years ticked by the index fund repeatedly beat the hedge fund. The Bet ended Dec 31st 2017 with the results being that the hedge funds gained only 2.9% a year after fees (which were large) while the index fund gained an average of 8.5% a year. Buffett won The Bet.
Here's is a recap of Warren Buffett’s 10 year bet: A Recap of Warren Buffett’s 10 Year Bet on the S&P 500
At the time I learned about this, it blew my mind!
This bet beautifully showed me how an index fund works if you just give it time and it showed me that for those who don’t have a room of fund managers working for them, it's better to just index. Heck for those who DO have a room of fund managers working for them, it is STILL better to just index! Up until this point I thought “how on earth could I pick through the rocks to find the diamond?” When I learned about index funds, thanks to John Bogle I realised I didn’t have to. When I learned that I didn’t have to try to learn how to pick a fund manager or stocks my relief was immense. Finally, a way to get in the game!
And get this, even though Warren Buffett has actually made his fortune by picking stocks, when he dies his advice to his wife is to put everything into index funds. But don’t stop at Warren Buffett, there was another book I read that really sealed the deal for me, The Simple Path to Wealth by JL Collins.
I read it cover to cover and then listened to him on more podcasts (such as this one from Choose FI: 019-JL COLLINS-THE STOCK SERIES-PART 1) than I could count, hearing him explain how index funds work as opposed to buying individual stocks. In his calm way he talked through every single objection I could think of and just provided a clear pathway to take. Buy a broad-based index fund consistently over a long period of time. And never sell. And go and do something else more interesting with my life other than watching stock markets.
After learning all this I just HAD to know where could I find this simple, low fee index fund in New Zealand? I had a sinking feeling that it would be like when I visited Canada and discovered the wonder of IKEA for the first time and realising that it didn’t exist in New Zealand. But thankfully index funds were well and truly already here and I pretty quickly tracked them down.
Today I have a monthly automatic payment that buys a set amount of just three funds:
US500 Fund (USF)
NZ Top 50 Fund (FNZ)
New Zealand Property Fund (NPF)
I never miss a month and when cash allows, I even make some one-off bulk payments and I’ve been investing this way for a number of years now and you’ll regularly see me refer to my investments and their performance on my blogs.
Since I started these investments about three years ago more and more funds have come onto the market, many are now sector specific (technology or water for example) but this whole way through, apart from the property fund, I’ve just stuck with the philosophy of “broad-based funds” and I have purposefully NOT dived into a sector (with commercial property being the only exception). By choosing a myriad of other funds you can EASILY double up and invest in the same thing in many different funds, so my thoughts on this are just pick a couple of funds and consider yourself done. For me, by choosing just three funds I have an immensely diversified portfolio, I’m investing into the US which has global companies within it, but I’m also investing in NZ as well. By buying the NZ Property Fund I’m getting a slice of commercial property too. And don’t forget too, that most of us have KiwiSaver and the fund I’m in ALSO invests into each of these areas - so although I try not to double up, it can be a little unavoidable, hence me sticking to just three funds.
When I first started, buying directly with SmartShares was my only option to purchase really. There were the likes of Investnow, but at that time their site was clunky so I’ve never gone back to it. But more recently EASY to use platforms like Sharesies and Hatch (which lets you invest directly into the US share market) and more recently the likes of Kernel have come on the scene, making becoming an investor easier than ever. A number of these sites offer you access to individual shares, but I just stick to my funds and ignore the rest.
Here I am going to share an email I wrote last week to a new and keen investor asking if now was a good time to begin investing. I wanted them to think carefully about their entire situation before starting to buy anything at all.
Hi,
Personally, I see this as a good time for me to continue to invest, but I’ve got a bit of knowledge behind me now as to why it’s a good idea for ME:
We have no debt
We have a KiwiSaver fund each
We have an emergency fund in place of six months of expenses
We budget carefully
Our income is volatile, but workable
Because we have ourselves in this position I’m happy to invest. The main reason being that we don’t need access to any of the money that we have invested for at least 10 years. And that is the key, as you have worked out, the share market is very volatile, but over time it always goes up. So, we never want to be forced to sell in a market like we find ourselves in right now.
I’m going to give you a few links to follow up before you even consider investing a SINGLE hard earned cent:
Back to Basics: Steps to Achieving Financial Independence
JL Collins: Stock Series
Choose FI: 019-JL COLLINS-THE STOCK SERIES-PART 1
HATCH Getting Started Investing Guide - I did this FREE course and found it super useful! 10 minutes a day for 10 days.
John C. Bogle - The Little Book of Common Sense Investing - this is for the nerds only.
Thanks John C. Bogle for Making Investing Simple
That’s a fair bit of reading for you, but if you don’t take the time to do it I fear you are getting involved in something you don’t understand, and that is the worst way to go about it - and the reason that many Kiwi’s freaked out and changed their KiwiSaver provider within the last fortnight I should add.
Personally, I only invest in a couple of funds. You will read on my blog and via JL Collins why index investing is a better proposition than guessing on individual stocks.
So, see how you go! I hope you have time on your hands to follow these links through, you won’t regret it.
Happy Saving!
Ruth
Final thoughts…
My final thought is to labour the point I have already made. Investing used to be this labour intensive/brain intensive exercise that only your friend's uncle did. It was kinda this secret world and only those in the know could get ahead. As a result a lot of people think they have to always be DOING something with their investments and they therefore want to tinker and buy and sell and keep adding investments.
Don’t. Just don’t!
Just pick a couple of funds that give you a broad exposure to equities (shares) in your home country and overseas and never miss an opportunity to invest, month in month out, year in year out, known as ‘dollar cost averaging’. Automate the process so you don’t get in the way of it. Boring, yet effective.
SO, my advice to you, given the fact I’m not a financial advisor and that these are just my opinions is to follow up on these resources before you invest a single cent. And when you have decided on the right investment path for you, never stop investing. Through low markets like we have at the moment to the highs of the future, buy steadily, buy consistently and never sell.
Then get on with doing something far more interesting with your life.
