Let’s talk about why index funds are the best investment for new investors – but let’s do it in a way that doesn’t require a finance degree.
It’s probably important to mention this is simply my opinion based on my own research and experience, but I’m going to share it with you in terms you can easily understand; no finance-bro talk here.
What Should a First-Time Investor Invest in?
Technically, you can invest in anything you want, but it’s a good rule of thumb to invest your money only in things you understand – so beginning with simple investment products is a good starting point.
As a new investor, keeping things simple will allow you to get your feet wet, explore your personal risk tolerance (how comfortable you are with the possibility of losing money), and determine your goals for investing.
The Best Investment for New Investors
There are so many different types of investment vehicles available in this day and age.
And with it feeling like new types are in the media every month *crypto has entered the chat* the world of investing can seem like a very scary place.
That’s why it’s so important to narrow down your choices to things that feel somewhat “less scary”, do your research, and just get started investing.
The longer you wait, the scarier it can feel.
It should go without saying that just because something is “the best” for one person, doesn’t necessarily make it so for the next, but I’m going to go out on a limb here and say that I believe index funds are the very best investment for new investors.
What is an Index Fund, and How Does it Work?
It would probably help if we define index funds before I tell you how amazing they are, right?
Cool. If you’re not familiar with index funds, in layman’s terms, they are simply a type of mutual fund you can invest your money in.
You can invest in index funds in a regular taxable brokerage account or through your tax-sheltered retirement accounts such as your Roth IRA, Traditional IRA, employer-sponsored retirement accounts (depending on what they offer), and the like.
What sets index funds apart is when you purchase an index fund, you are actually investing in a small piece of every single company that exists in that specific index.
Yes, that’s a very generic explanation – there’s so much more that goes into index funds, but remember, we are keeping this list easy to understand and not filled with a ton of “bro” talk that makes our head spin.
I’ve learned everything I share in this article by doing my own research over the past few years in an effort to build a solid investing foundation.
If you’re a new investor or want to begin investing, I recommend you do the same.
Here are five reasons I love investing in index funds for retirement:
1. You Can Have it All
Remember, index funds include a portion of every stock in a particular index, which naturally makes them diversified.
Had I begun investing at 18 years old, I would have been much more aggressive with my investments and likely would have listened to everyone who told me that individual stocks are the best investment for new investors.
But today, as a woman of…ahem…middle age, I prefer to take a slightly more conservative route.
Again, abiding by my rule of “not investing in things you don’t understand,” I really don’t have the time or the interest to go out and research specific companies to get an in-depth understanding of the stock market itself.
I’m not exactly comfortable with my future financial security hinging on my personal knowledge of individual companies and stocks, yet I absolutely want my money invested in the stock market.
If you find yourself in a similar situation, you could take your money and spend “$ x” amount on Apple stock, “$ x” amount on Amazon stock, and “$ x” amount on Tesla stock and risk your financial future on the volatility of these individual companies.
However, if instead you purchased an S&P 500 Index Fund, you would still be investing in those same three companies plus all the other companies in the S&P 500.
And because you’re investing in every single one of those companies, it offers you a different level of protection vs. investing in individual stocks.
When you own a small piece of all of the stocks in the S&P 500, yes, sometimes some of the stocks will do poorly, but that will often be balanced out by the companies that are doing well.
Essentially, index funds offer the ability to have it all while still being diversified and maintaining a reasonable comfort level that you won’t lose it all overnight!
2. Index Funds Have Low Management Fees
When investing in mutual funds, the funds carry fees to offset the cost of managing the funds.
Typically, index funds have much lower fees than other mutual funds.
You’ll sometimes hear these fees referred to as “expense ratios,” but since this is an article for regular people, we will just refer to them as fees.
Index funds are passively managed, whereas mutual funds are actively managed.
I like to think of mutual funds as being “high maintenance” funds and index funds as “low maintenance” funds.
Mutual funds incur higher costs for marketing and management, which are passed on to their investors.
And while fees will vary amongst different funds, index funds typically require little management (they’re “low maintenance,” remember?), so the costs passed on to the investors will be substantially lower.
When looking at mutual fund fees, they will appear to be a small percentage.
However, when we look at how compound interest works, paying seemingly low fees can equate to tens of thousands of dollars in potential compound interest you may be missing out on, which can have a massive impact on your investment account over the span of a few decades.
3. Index Funds Are Simple
Index funds stand out in a space often deemed “complicated” because they’re simply…well, simple!
Maybe for you, investing doesn’t feel complicated, but for many others, it can be incredibly overwhelming.
Because there are so many different investment options and opportunities, each one being nuanced, investing can scare away many potential investors who are otherwise willing and able to begin investing.
Not only does their simplicity make them the best investment for new investors, but if you’re anything like me and suffer from a serious case of F.O.M.O, you’ll love them even more!
Hearing about the current hottest stock no longer tempts me to grab my phone and immediately deposit all my savings into my Robinhood account.
The likelihood is that I already own a piece of this company in my index funds (completely dependent upon which index funds you invest in, of course).
Conversely, if you’re getting awful news every time you turn on the TV about a stock you’re heavily invested in, it’s going to scare you and make you worry about the state of your investment account.
Owning a piece of that company through your index fund, you will feel more confident it will be balanced out by the rest of the index and not lose sleep over it.
4. Index Funds Tend To Outperform Regular Mutual Funds
Believe it or not, index funds tend to outperform actively managed mutual funds.
Although the market can (and has) experienced significant drops over time, historically, the market has consistently trended upward.
Of course, as an investor (of any type), you’ll experience some downturns, as nothing is a sure thing 100% of the time.
But if we look specifically at the S&P 500 from our earlier example, it has posted an average annual return of almost 10% since 1928; therefore, if you owned an S&P 500 index fund, you would have experienced a similar return.
5. Set it and Forget it
I look at investing for retirement as a marathon, not a sprint, and I encourage you to do the same.
Decide that you will begin saving for retirement without getting caught up in the day-to-day ups and downs of the markets.
Make a plan to invest consistently, as much as you can, and forget about it.
If you set up your contributions to be automatic, you can literally “set it and forget it.” Don’t obsess constantly about the gain/loss of your account each day.
Knowing that you’re investing for your future as much as you can in good quality index funds with no plan to touch your account before you’re of retirement age will help you sleep better at night and remain virtually unaffected by what’s going on in the stock market.
Investing in this way will give you a sense of freedom instead of keeping you constantly tethered to the news, worried you’ll lose your entire nest egg the next time Reddit goes wild with stock advice.
I’m comforted by the fact that I’ve done my research, and I’m confident in where my money is invested (in index funds), and I want the same for you.
You have so many other important things to focus on and worry about each day, so investing in index funds will allow you to take “worrying about my investments” off your list.
If I’ve successfully convinced you that index funds are the best investment for new investors, I hope you’ll take the next step to learn more about how to set up an account and which funds are best for you.
I highly recommend you enroll in Build Wealth by Investing in Index Funds if you’re ready to begin investing and are completely green, already are investing but could use a refresher, or want to brush up a bit on the fundamentals.
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