One of the major problems with stock investing is your own emotions. It’s important to invest in the stock market, of course, but how to invest in stocks is an open question.
It should be without worry, or you are likely to make a highly emotional decision at precisely the wrong moment: You might chase a “winner” until it collapses or sell out of a long hold at exactly the bottom.
The trick with stock investing, then, is diversification. Owning a broad selection of stocks greatly reduces the risk of overreacting to news headlines, for instance.
Investors have long done this by owning mutual funds. For many years, this approach made sense, on the face of it. You got to outsource the worrying about which stocks to buy to a professional.
With a mutual fund, it didn’t matter if Exxon was up or IBM was down or the reverse. A mutual fund manager took care of the details.
Yet the results of those managers opens up another source of worry. Fund fees are steep and they compound over time. Now, instead of picking the right stock and selling it at the right time, you have to make sure you pick a manager who can consistently beat the market after fees — and those are few and far between.
In fact, it’s pretty close to impossible. During the 1980s and 1990s bull markets, time seemed to heal all wounds. Yet the cost of those fees as they steadily compound ends up being real money, between 30% and 50% of your total return over decades.
Think about that. If you manage to get a 10% return in the first year, your mutual fund fee seems like nothing. But it’s not nothing. It’s real money taken from your account and lost to you forever. Over time, that starts to hurt.
The solution is to invest using index funds. With no manager to pay, costs are extremely low. An index ETF can be purchased now for 0.04%, compared to 1.27% for a typical actively managed mutual fund.
Moreover, you own in the index fund hundreds and even thousands of stocks. If they pay dividends, that cash flows to you in proper measure, even in an ETF. A dozen major companies could go bankrupt and you’d be fine.
Now, your only real source of worry is a total market collapse, which can happen. That’s why retirement savers should use a portfolio approach that combines investment types to account for risk, rebalancing along the way.
You can learn how to invest in stocks without worry. All it takes is a simple collection of ETF index funds and a rebalancing strategy to keep risk in check.