When I first looked into investing, it was like staring across the Atlantic Ocean. All I could see was a vast, churning deep, full of danger [1] that could swallow my wealth whole.
I needed help to sail these seas, and among the competing offers I found a trusty vessel named index investing [2].
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While you can make the journey in expensive luxury liners like actively managed funds [4] or in a one-man skiff tossed hither and thither by your own stock picking [5], here are five reasons why a more modest seeming vehicle – a portfolio of index funds – makes the most sense:
1. Index investing is simple
Never invest in anything you don’t understand is a mantra repeated time and again in personal finance. Like never crossing the road between parked cars, it’s excellent advice that’s all too easy to ignore.
Happily, index investing is easy to understand, even for those with little investment experience.
- You use simple index tracker funds [6] or Exchange Traded Funds (ETFs) to construct a diversified portfolio [7] that keeps your eggs in many baskets.
- You make regular contributions to your funds and rebalance [8] your portfolio as little as once a year (some prefer never).
- Holiest of holies: You don’t try to time the market or pick hot stocks.
2. Index investing works
Index investors will beat the average active investor after costs and taxes, according to Nobel Prize winners like William Sharpe [9] and legendary investors like Warren Buffett [10].
Study after study shows [11] that most actively managed funds are trumped by index funds over the long-term. Why? Because index trackers are dirt cheap. Their low costs nibble away less of your pie than pricier active funds [12], which rarely put in the consistently stellar performance required to justify their high fees.
Index investing is not a ticket to instant riches. It doesn’t aim to beat the market, but rather to capture the returns of the market. We’re putting our money on the tortoise, not the hare.
3. Index investing is affordable
Cheap index trackers can be bought from online brokers [13] like Hargreaves Lansdown [14]. You can buy in small, regular chunks and build up your portfolio slowly over time.
With a bit of confidence and self-education you can manage it all yourself. This means you avoid paying commission or fees to a financial advisor.
4. Index investing doesn’t waste your life
Stock-picking hoovers up vast amounts of time. Index investing leaves you free to sniff the roses. There’s no need to grapple with complex methodologies, pour over company accounts or entangle yourself in charts.
5. Index investing puts you in control
Ever hire a dodgy financial advisor [15] only to discover later you’re paying sky-high fees for mediocre funds that didn’t suit your needs? (Or was that just me?)
Knowledge of index investing strategies can help you avoid a similar fate by revealing:
- The risks you’re taking and how to dilute those risks to a level you’re comfortable with.
- How much [16] you need to invest to achieve your financial goals.
- A DIY approach that avoids rip-off merchants and saves you a bundle in the long term.
- Good questions to ask an advisor should you still want to hire one, which will help you find one of the good guys to work with.
To get you started we’ve a huge library of passive investing articles [17] here on Monevator.
Dive in, and happy investing!
The Accumulator