The Laziest Way To Riches – Investing in Index Funds
I’ve said it before, and I’ll say it again: I’m a huge fan of the path of least resistance. In fact, I’d say I’m its biggest fan. I believe that the shortest distance between two points is a straight line and that the beer hat is possibly the greatest invention in human history. And while I love talking and writing about finance, I know there are people out there who would rather spend their days doing other productive stuff like jobs, tinder, crushing candy on your phone…
In light of the fact that you’ve all got better things to do than worry about your portfolio day in and day out, I’ve come up with probably the simplest plan out that exists for getting yourself the amount of money you need by the time you retire. But first, a quick discussion about risk…
What is Risk?
A fucking awesome game, that’s what.
No, I’m totally kidding. The reason we need to talk about risk is because a lot of the choices you make in daily life involve you trying to determine the amount of risk something entails. Simple example: trying to make it through an intersection when there’s a yellow light. Now, there are a number of risk factors that go into you making the decisions to blow through the light like your Vin Diesel on Bath Salts or behaving like a functional adult in society. Those factors may (or may not) be:
- How fast you’re currently going
- How much you can speed up
- The distance to the light
- Whether or not you see any cops around
- Whether you live in a town with lights at the intersection
…and I’m sure a whole bunch of others. But the other half to this great urban planning puzzle is why are you trying to go through it in the first place? Are you:
- Trying to be a badass?
- Late for work?
- Trying to leave a pile of meth at a drop-off so you don’t miss the birth of your daughter?
All these factors play into your decision. And in the same way that you’re estimating your risk of not making it through the light vs. the reward for doing so, you will make your financial decisions. The key point to all this is that in general, you won’t risk a lot if you don’t think you’re going to get a lot. In the example above, you’d probably go through the intersection if you were driving your pregnant wife to the hospital, but not if you were dared to by a buddy in the backseat.
This concept of risk vs. reward is literally the foundation of any market. What happens if I sell my house now vs. next year? What if I try to retire at 50, and not 65? But today, we’ll be talking about two types of risk that exist in the stock market. Buckle up, cuz we about to get technical, y’all…
Systematic and Unsystematic Risk
Risk comes in all sorts of shapes and sizes, but fancy financiers and academics have essentially come up with two different kinds of risk. And since textbooks don’t make it that simple to understand, I’m going to give you a couple of examples.
Systematic Risk – This is risk that you really can’t erase. For example, you cannot control how many idiots there are on the freeway, and how many decide to pass you on the right at 90 miles an hour or use their brakes the way a Kardashian uses collagen. But for the most part, people can’t get around without a car, or at least some mode of transportation.
The financial context for systematic risk is if a tornado swept through the HQ and demolished the building, or if there’s a huge market crash because of a coding error at the NYSE. These are things that can’t be controlled, and as such you can’t really get rid of them.
Unsystematic Risk – This is the risk that you can make go away, or risk that’s really not necessary. For example, let’s talk about bull riding. A completely unnecessary sport, and one that most people choose not to partake in. Why? Because it’s dangerous as hell. “Bull riding” is a risk that you don’t have to take, or one that you can make “go away.” (and frankly, what’s the reward in bull riding? Everyone get’s thrown off in the end anyway…).
In a financial context, this would be like the value of a stock going down because the CEO was caught in an orgy, or the CFO signed off on obviously fraudulent financial statements. These are easily controllable by the managers at the firm (CEO should have been more careful not to get caught, or the CFO shouldn’t have signed off on those documents).
So while you can control the risks you take in terms of your decisions, we do not operate in a bubble all by ourselves, and as such have to deal with some risk every now and again.
Great, so why are we talking about this?
Because in order to get rich in the laziest way possible, you have to try to get the most amount of reward for the least amount of risk. The best, and simplest way to reduce as much risk as possible (the systematic risk) is through… drumroll please…
Now I’m not going to go into all the math of how diversification works (if you’re really dying to know, check out diversification here), but essentially, you can make the same amount of returns over a given time with less risk. Here’s what this looks like.
Shut up. I write, not draw.
Hopefully this is obvious to you, but do you see how the red graph spikes more than the blue one? That’s because the red one is more volatile, another way of saying it’s more risky. The blue is more ideal, as over time there is less fluctuation than the red. The question then becomes… How do I get these diversification benefits?
Well you could buy a whole bunch of stocks on your own, or you could start…
INVESTING IN INDEX FUNDS
The index fund is probably the most useful financial instrument for individual investors since the mortgage. Simply put, and index fund is going to track a stock index and try to deliver the same amount of risk and reward. A manager will collect money from thousands of people, pool that money, and use those funds to buy hundreds of stocks. They’ll use a whole bunch of fancy math to make sure that the fund matches a stock index.
A stock index is simply a grouping of stocks. This grouping of stocks is generally considered the “thermometer” of the stock market. There are several stock indices out there, some of which you’ve probably heard of before. The Dow Jones Industrial Average, the SP 500, and the NASDAQ are the three most followed and familiar stock indices in the United States.
An index fund is going to hold most, if not all, of the same stocks that are in a specific index. For example, the Dow Jones Index Fund will contain most of the stocks that are listed on the Dow Jones Index.
Key Takeaway – When you buy an index fund, you are essentially buying “the stock market”.
OK, so I reduce risk. Why else should I be investing in index funds?
Well, dear reader, let’s go through the list.
Automatic Diversification – Back before their existence, diversification had to be done by the investor. Which means you would have had an assload of calculations to go through before you could even pick up the phone to call your broker. Thanks, no thanks.
Cheap – Index funds are by far some of the cheapest financial instruments to buy out there. I don’t own any index funds whose fee’s are above .2% a year. That means for every $10,000 I have invested, I pay $20 to have it managed. This, compared to the 1-2% fee you see for most mutual funds, and the 2 and 20 rule you see for hedge funds. Over the 40 year time span you should have, that 1-2% adds up to tens of thousands of dollars!
Performance – Index funds, by and large, have outperformed actively managed funds year in and year out. Now, are you going to be able to find actively managed funds that have out performed the market this year? Yes, absolutely. Are they going to be the same funds that outperform next year? I’d be willing to bet they won’t be. Index funds deliver the highest consistent returns of any financial instrument that is publicly available.
Ease – Check the beginning of the article, guys. I’m not about doing a ton of work for little to no reward. If I’m going to make financial decisions, then they’re going to be made in the context of making me money and saving me time. Index funds hit both of those goals. I buy a fund that literally buys close to 500 stocks, and all I have to do is press “Buy” once. Do you have any idea how long it would have taken to buy 500 stocks, especially back in the days before index funds existed? You would have been on the phone with your stock broker for hours. Now, all you have to do is click “Buy” and you now own (very tiny pieces of) hundreds of stocks.
How to start investing in index funds…
The first step would be to open either a Roth/Traditional IRA with an online broker, and then buy the index fund that matches your specific goals. Since most of you reading this are somewhat fresh out of college, here are my recommendations:
Charles Schwab – I’ve been with Schwab since 2013, and have never had a single issue with them. They offer quite a few index funds, but the one that I would encourage new investors to focus on would be the “Schwab S&P 500 Index Fund” (Ticker Symbol – SWPPX). It tracks (surprise) the S&P 500, and makes a great start to any portfolio. The expense ratio for this fund is at .09%, which means for every $10,000 you invest, you pay Schwab $9. There is simply no better deal. And the minimum funds required is $100. If you’ve followed my tips on side jobs then you should have at least that much to invest!
Schwab also has lots of tools online that allow you to check your performance, screen stocks, use different financial instruments, and have a chat function to talk to representatives. Overall, very simple interface and customer support has been great!
Vanguard – If you haven’t heard of Vanguard yet, you should have. They’ve been the mac daddies of index investing since before it was popular or cool. I’ve opted for some specialized ETF’s through Vanguard (don’t worry about those just yet), but there are numerous Index funds that track all sorts of indices. If you had to buy one, I’d suggest the “Vanguard 500 Index Fund Investor Class” (Ticker Symbol – VFINX). Disclaimer – I don’t actually own that one, because I already have an index fund that does practically the same through Charles Schwab. It’s got an expense ratio of .16%, which is still much lower than most actively managed funds.
There is one kicker. Vanguard requires a minimum investment of $3,000 to get started. If you have the funds, then get going. If not, keep saving up till you can!
Some other brokerages that I’ve heard good things from are T. Rowe Price, Scottrade, and ETrade. However, I’ve never used them myself and won’t personally endorse them, but I would say they are worth exploring if the first two I mentioned aren’t your satisfaction.
OK, great. But how does this GET ME RICH?!
As I said before, the quickest route to getting rich is owning businesses, and the stock market allows you to do just that. But how much has the stock market returned over its history?
Well, you’ll find lots of numbers from fancy people trying to be impressive with mathematics. The range that’s given is somewhere between 7-10% a year. For arguments sake, let’s say you will get a 9% return on your index fund investment. If you put away $5,000 a year, it will take you just over 34 years to hit millionaire status.
34 years?! WTF?! THAT’S GOING TO TAKE FOREVER!
I hear you bruh, I hear you. But let’s keep some things in mind. First, this is the laziest way to riches. This requires absolutely no talent on your part. All you have to do is set up an automatic payment, and just not turn it off. A monkey could figure out how to do this. Second, this is assuming you put away roughly 10% of your income. You’ll eventually read why I think that’s a terrible idea, and that in fact you should be putting away more. If you double your yearly contribution from $5,000 to $10,000, then guess what? Your one million dollars just turned into 2 million dollars.
Yeah, now we’re getting somewhere.
Third, this assumes that you only make $50,000/year for the rest of your life. Not a great assumption, as your salary will likely increase. Finally, this doesn’t include any side businesses you may start, or other investments that may do better (like real estate).
The Key Point?
YOU’D HAVE TO BE A COMPLETE FOOL NOT TO RETIRE A MILLIONAIRE!!!
There, I said it. And I mean it, too. You’d have to completely disregard a hundred years of stock market performance and thousands of experts that say that this is the way to get rich!
So get out there, open an account, and buy your index funds TODAY!
The Laziest Way To Riches – The Wrap Up
Getting rich is simple. It requires a little bit of work on your part, but overall, we live in a day and age where your computer is going to do most of the work for you. To sum up why this is…
- There are different kinds of risk, some that you can get rid of some that you can’t.
- The reason we all take financial risks is for financial reward.
- We want to get rid of as much risk as possible, but still reap the benefits.
- DIVERSIFICATION is the only way to reduce these risks.
- Index funds give you instant diversification and other benefits.
- If you’re not a millionaire by the time you retire, than you’re a dim-dim. Sorry.
Your next steps:
- If you haven’t signed up for a brokerage account, sign up for one TODAY!
- When you do, comment below and let me know what brokerage you chose and why.
- If you already have an account, tell me about the success you’ve had with index funds!
Thanks for reading boo boo’s, and as always…
Keep trying to crack the code,