The best investment advice I can give
Or "what is a low-fee index fund, and how do I find them?"
After some recent conversations with a couple subscribers1, I’m taking a slight detour away from my regular “find the greatest stocks” theme. Instead, for those of you who aren’t huge nerds with code to access finance data and spare time to stare at it, I want to introduce you to something simpler and hopefully more relevant and more useful.
I.e. I’m going to introduce you to low-fee index funds.
Today, I’ll answer these questions:
What IS an index fund?
Why are they a good idea for most people?
How can we invest in one?
If at the end you cannot find these indexes (or similar offerings) in your own personal investment account, leave a comment and I will try to help out.
How stock market industries are like high-school cliques
Remember when you were in high school or university and there were different groups of students? Some kids from wealthy families who tended towards careers in law or medicine. The nerds who probably played and or wrote their own game code and probably aimed for a career in IT. Guys who wanted to work with their hands, plumbing or other trades, or maybe wanted to start their own transport or heavy machinery business. Sports teams and athletes who wanted to be personal trainers, some math-heavy engineers, a couple wanted to join the military, and there was probably some fucking annoying dude who’s mouth moved a million miles an hour and always had some deal (read: scam) that he wanted to pitch you.
Turns out the groups you knew while studying are a rough but decent analogy for the stock market and the companies whose shares are traded there. There’s biotech companies researching new medicines, tech companies writing software, trucking companies transporting goods, defense contractors and hardware stores and grocery stores and sales and marketing companies, wildly over-hyped companies and slow, steady companies and so on…
Now imagine that regardless of which career YOU pursued, you also had the chance to partner up with whoever you wanted from your school days. Kind of like making a bet on their future career because you believed they would likely do well, and you want to share in their success and maybe also spread around some risk in case your own career path doesn’t go quite so smoothly. This would make you something called an “active manager”- you are actively, consciously trying to review the options, and pick a few good bets.
Again, this is basically the opportunity you have with the stock market. You can take whatever savings and spare cash you have each month, and choose to buy shares in different, individual companies if you have strong beliefs that you know which ones will be good bets. Kind of like how you might know some bass-playing stoner from cooking class who would grow up to be a millionaire, but its probably more likely that you’d want to join forces with the chick who got straight A’s in all her subjects and was already working to establish her own consulting company.
Right so, what is an market index and and index fund?
A stock market index2 is basically just a collection of companies, often chosen because they share some similar characteristics such as industry of operation, company size, geographic location, etc. An index fund is just a way to buy shares in those companies simultaneously, so that the shares you hold match the companies in the index.
Imagine that instead of being an active manager, you were actually not confident to predict exactly which of your fellow students would go on to great success and which would fail. Rather than bet on any one person, you instead want a way to spread out your money and your bet.
You might choose to bet on all the IT nerds assuming that even if a few burn out, most will end up working as well paid programmers and a few might even start the next Microsoft. ZING: you made a Tech index!
Or you might choose to invest in the nursing students and the medical engineering students, assuming that as time goes by we’ll need more health care practitioners AND the miracle drugs to support them and so those students will, on average, do well in future. BAM: you made a Healthcare index!
Or maybe you want even less hassle.
Rather than try to pick a single winning student or even particular winning industries, you instead decide to bet on ALL your fellow classmates. You know that some will keep smoking too much weed and probably not achieve much financially-speaking, some will build companies and hire hundreds or thousands of staff, and most will land somewhere in between. On average, by betting a little on everyone, you participate in the collective prosperity and future of a large, diverse group of people. Congratulations, you built yourself a passive3 full Market index!
And so on, you get the idea.
Market index: any group of companies bundled together for some reason (sector, industry, geography, size, currency, etcetera)
Index fund: a way to easily, and ideally cheaply, buy shares representative of that index group of companies. That’s it.
Why is index investing probably the best option for most people?
Without going into a huge side rant about the financial industry as a whole, it is safe to say that unless you really, really, really want to devote a lot of time and effort to managing your own investments, if you instead invest in a low-fee, passive stock market index:
You avoid the hassle of having to learn accounting or deeply investigate companies as investments
You avoid the distraction (and total, utter waste of time) of following financial news regularly4
You avoid the very high fees that most professional fund managers charge to recommend you individual stocks or invest your money on your behalf, and
Research suggests that actually, over the long term, many if not most low-fee index funds will also actually perform BETTER than those same expensive professional fund managers, despite their marketing claims and smooth sales pitches
As I wrote earlier5, Fees are the Wealth-Killer6 . When you actively buy and sell individual shares based on stock tips, or pay someone to do it for you by investing in an actively managed stock market fund, more often than not the active fees reduce the outcomes and take money from your pocket.
Alternatively, owning 1-3 varied index funds, with a broad exposure to different industries and geographies, will probably give you better peace of mind, acceptable long term investment returns, and is a whole lot less effort, meaning you can pretty much set-and-forget until you are ready to retire.
How can I invest in a good, low-fee index fund?
There are thousands, literally THOUSANDS of indexes and investable funds out there. There are actually MORE funds7 than stocks8, think about that! But fear not, you can skip 99.999% of these indexes and just pick a couple of the biggest, best and cheapest, according to your personal preferences.
Selection considerations - diversifying geography, currency and industries
Lets say you live in Australia. Your Superannuation is probably already invested heavily in Australian real estate, Australian stocks, and Australian government bonds. So you might want to spread out your investment universe and invest your spare cash in an overseas index representing North America, or Europe, or a full Global index representing a bit of companies from everywhere, in every currency and every industry. You could choose to narrow the scope to Tech-only companies, or Healthcare companies, or Industrial companies,
Or perhaps you live in the USA, but you think Asia is likely to boom in the coming years. You might pick something local and representative of America, like the SP500, but you might select a second fund like the Developed Asia Pacific All Cap index, which “Holds stocks of companies located in Japan (the major index component), Australia, Hong Kong, New Zealand, and Singapore” and charges less than 0.10% fees to participate.
Selection considerations - fee levels
Speaking of fees, what do we consider low, reasonable and excessive?
Investopedia tells us “A reasonable expense ratio for an actively managed portfolio is about 0.5% to 0.75%, while an expense ratio greater than 1.5% is typically considered high these days. For passive or index funds, the typical ratio is about 0.2% but can be as low as 0.02% or less in some cases”9
Passive / index funds have lower fees than active funds, because the managers are spending less time and effort trying to pick winners. Instead, they buy a bit of everything, then chill out and relax, and because there isn’t much work involved, they can operate very efficiently, at low cost and charge very low fees for their service, and you as the investor keep more of your money in your own pocket as a result.
So check carefully (and comment below if you want me to help you check) — are the fees on your fund reasonable or are they excessive?!
Finally, a few options you might consider
Depending on where you live and what brokerage account you have, the actual funds available to mimic these indexes will differ, but some of the better-known indexes (that I myself consider reasonable10) and you might too, include (in no particular order):
The Standard and Poors SP500 index: a selection of the biggest, generally profitable and successful U.S. equities. The index includes approximately 500 leading companies.
Vanguard offer a low-cost fund called the VOO11 for as low as 0.03%, find it here on Nordnet, as SPY on Commsec Australia and on Charles Schwab as SWPPX in the USA.
The Nasdaq Technology / 100 (USA-based, Tech-focused): e.g. variations for all tech or top 100 tech companies in the USA, more concentrated and likely more ups and downs than most funds, but in theory, should do okay in the long term if you invest a little amount regularly
A “Total World” index that tracks stocks and companies located in both developed and emerging market countries (i.e. rich and poor) from around the world. Something like the FTSE Global All Cap index will invest in companies of all sizes, and can be found
Final takeaways
Ultimately, it will matter less which one of these many good, diverse, low-cost options you invest in, so long as you
get started today
invest regularly over time
do NOT look at your portfolio bouncing up and down in price every day, or every week, or even every month, or even every year… prices will bounce up and you’ll feel richer, and they’ll bounce down and you’ll be able to buy more at a discount before they bounce up again.
invest regardless of whether the market is going up or down or what news headlines you read or what the price of oil is or whether there is the threat of nuclear war or Corona Version 24 comes out…
remember that the market currently going up or down has NO bearing on long-term investing.
To steal a great slogan from another investing blogger, Just Keep Buying.
Post a comment below if you would like to get in touch and discuss more index fund options depending on your own brokerage account, I am happy to help out where I can.
Thanks for reading, more soon…
Special shout-outs to Sampsa and Sara for inspiration for this post
“Passive” because there are no careful, individual selections taking place
Stock market news agencies only get paid if a) you click often to buy/sell what they recommend or b) you return to their sites daily out of fear or greed to see what they recommend. The only problem with that industry is that their headlines are clickbait doom-scrolling material, their timelines are all short to attract your attention and make you focus on meaningless things, and all their recommendations are bullshit. Other than that, I guess they are fine…
Yeah, I’m waiting for the new Dune movie to come out, so sue me…
With all the usual financial advice disclaimers in Full Effect