In this article, I explain why you need to invest in index funds.
Like many people, I want to grow my savings in order to to complement my retirement income.
I am almost 30 and hope to retire by age 65 so this means I have a 35-year investment horizon.
The question is: What is the best, low-risk way to generate sufficient capital to retire comfortably?
One obvious way to generate wealth is by investing in real estate. This is a powerful tool which everyone should take advantage of if they have the opportunity. However, contrary to popular belief, it is not necessarily the BEST way make money.
Indeed, the best way to create wealth is through stock market investing.
Americans certainly know this and a recent Gallup poll revealed that 55% of Americans own stocks.
If you don’t already own stocks, chances are you are wondering how the stock market can help you create wealth. This article will present the easiest, safest and most reliable way to generate substantial returns in the stock market.
1 – Understand the stock market is not a casino
A lot of people don’t invest in stocks because they perceive the market as being a casino. They are convinced that the small investors always get taken to the cleaners by the big boys. In fairness, this is partly true: Many beginners start day trading (an activity which consists of buying and selling stocks on the same day) hoping to make lots of money quickly. The truth is that day trading is an extremely difficult endeavor which requires years of experience and great discipline. Furthermore, large institutions have great resources – technological, human and financial – which give them a sizeable edge over retail investors. In sum, beginners should avoid day trading altogether.
Another misconception many beginners have is that stock market investing consists of investing in highly speculative stocks. This is called active investing and it is also not recommended for beginners. While active investing can generate substantial returns if done correctly, it can also lead to disastrous results if one or more stocks perform poorly and ravage your capital.
Thus, beginners should forget about the “casino” approach of trading and buying individual stocks. Instead, they should adopt a time tested strategy, proven to generate consistent returns: investing in ETFs.
2 – Why ETFs are Awesome
An Exchange Traded Fund (ETF), also called an Index Fund, is a fund composed of hundreds of stocks or bonds. Simply put, an ETF is a basket of stocks or bonds which reproduces the performance of a given index. There are ETFs for almost all imaginable sectors, including stocks, bonds, commodities, gold, silver, agriculture, water, etc.
Contrary to individual stock picking, ETFs are passive investments: They reproduce an index and track its performance. The investment funds who create the ETFs manage them for you, which means you don’t have to bother figuring out which companies to include in your portfolio. Another advantage of ETFs are the very management low costs, which increases profitability. Active management, on the other hand, incurs transaction fees on every operation (buying and selling), which will negatively impact your long term profitability.
It is important to mention that ETFs also provide great diversification: An ETF which tracks the performance of a major stock market will include transnational companies who do business in the entire world. Thus, you benefit from immense diversification without worrying about the underperformance of an isolated company. If several companies underperform and their stock prices tank, this will not have great impact on the overall performance of the ETF.
Lastly, ETFs are actively traded, meaning that you can buy and sell shares of them at any give time – during opening hours of the stock market where it is listed. This provides great flexibility as you can increase or reduce your position at any time.
3 – Three Great ETFs to Start
The most popular ETF is the S&P 500 ETFs, which track the performance of the 500 largest companies listed on the major US stock exchanges.
Here are three ETFs I particularly like:
i) The iShares S&P 500 ETF, which is composed of the 500 biggest companies listed on the US stock exchanges.
ii) The iShares Nasdaq 100, which is composed of the 100 biggest non-financial companies listed on the Nasdaq.
iii) The iShares MSCI World UCITS ETF, which is composed of the largest publicly traded companies in the world.
4 – Performance & Profitability
The question burning your lips is: How much money can I make investing in these ETFs?
Worry not, for this is what we are going to cover now.
Let’s start with the iShares S&P 500 ETF. Look at the graph: It is on a continuous upwards trend for the past 20 years. On My 26th, 2000, one share of this ETF traded for $137.84; 20 years later, one share trades for $352. This represents total growth of 155%, which corresponds to an average annual return of 7.76%. Decent.
Since 2012, the iShares World ETF generated total returns of 106.05%, which represents an average annual return of 13.25%. Juicy.
As expected, I saved the best for last: Since January 2011, the iShares Nasdaq 100 generated total returns of nearly 600%, which represents an average annual return of 60%. Insane.
5 – How much can I hope to make by investing in these ETFs?
As I mentioned in the introduction, I have a 35-year investment horizon.
Let’s imagine I choose to invest $1,000 in each of these ETFs and inject an additional $100 every month in each one. Let’s also assume that each of these ETFs will generate the exact same average annual returns going forward for the next 35 years, but let’s make an exception for the Nasdaq 100, which we will assume will flatten out to a 15% average annual return going forward.
Here are the expected results:
i) iShares S&P 500 ETF: My initial $1,000 investment becomes $216,604.50
ii) iShares Nasdaq 100 ETF: My initial $1,000 investment becomes $1,261,442,37
iii) iShares World ETF: My initial $1,000 investment becomes $815,317.74
Theoretically, after 35 years, my retirement portfolio will reach a total of $2,293,364.61, of which I contributed $126,000 and collected in $2,164,364.61 in interest.
Can your bank’s savings account come anywhere close to this level of performance?
Obviously, past returns are no indication of future returns and this simulation should be taken with a grain of salt as it is simply an exercise demonstrating the power of index funds. The total returns of this investment portfolio will be determined by the growth of the world economy and final profitability will have to factor in inflation. Nonetheless, it’s undeniably the best way to grow your savings into a comfortable retirement nest.
Note: Use this investment calculator to run your own simulations.
6 – How to invest in ETFs
I choose to invest in ETFs through online brokers because the fees are low and their platforms are incredibly easy to use. There are plenty of great platforms out there and you have to do your own research to find out which one is the most suited to your needs based on where you live.
If you live in the USA, you can also invest in ETFs through Roth IRAs and 401Ks. These methods of investing are very advantageous because they can offer tax benefits and employer matching which will help boost your profitability. In France, you can open a PEA through your bank and enjoy an absence of capital gains taxation if you hold on to your positions for more than five years – which you obviously will after reading this. However, a PEA limits the products you can buy and banks will also charge hefty transaction fees and custody fees, so conduct your own research before investing with them.
Lastly, you can also invest in ETFs through life insurance policies.
Ultimately, it is up to you to determine which method suits your investment profile and financial objectives.
Now you know that ETFs are the best long term investment you can make as a beginner. If you invest consistently over the very long term, you will generate substantial returns that will help you reach your investment goals.
There are plenty of ETFs out there but, if you are just starting out, it is highly recommended that you stick to the most popular ETFs which track the performances of the major stock exchanges. Once you own these ETFs and get comfortable with investing, then you can start looking at more sector-specific ETFs and buying individual companies.
Thank you for reading.
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DISCLAIMER: This article is the fruit of my personal research and should not be viewed as financial advice. I enjoy analyzing stocks and providing investment ideas but I highly encourage you to conduct your own research before investing in any asset. NEVER invest without having done proper due diligence and NEVER invest out of the Fear Of Missing Out (FOMO). Also, NEVER invest because some internet message boards are hyping up a high-flying stock. As a rule of thumb, the number of rockets included in a tweet are inversely proportional to the quality of the advice given.