A lot of Americans don’t have any savings, and many more don’t have any real investments. Remember, your home is never an investment <link>. But if you’ve been working to gain financial literacy and turn your situation around, you might start to have savings. And you might then start to wonder, how should I invest this money? I don’t know anything about investing. But I’ve heard you shouldn’t just let your money sit.
That last part is definitely true. You should not just let your money sit around, doing no work and being eaten away by inflation. You should invest it. Now there are a thousand ways to invest, but I’m going to give you the least-effort, highest-reward way that you can do it in today’s economy. It’s not some big secret that only I know, but since a lot of people don’t worry about this stuff, it’s still new to many people and it’s important to share. This is where you should start.
First, let’s define an investment. You put your money into something – stocks, real estate, bonds, a new skill, or new infrastructure – and you get more money out. When evaluating opportunities you worry about a few things. These things are effort, risk, cost, return, and liquidity. In other words how much work is it for me to maintain my investment, how big is the chance I could lose money, how much does it cost me, what can I get back, and how easy is it to get back?
Real estate, for example, takes a lot of work as an investor and is expensive and you can’t always sell it at the drop of a hat. This is why real estate investors tend to be professionals rather than average dudes with a few thousand dollars. Stocks and bonds, on the other hand, are very easy to put money in and out of, in any amount, and you don’t have to do much. These are low-effort, high-liquidity investments.
That ease of money in and money out is why individual investing is almost synonymous with stocks and bonds in most people’s minds. And that is going to be my recommendation. But there are still a lot of different ways to do this that have different risks and expenses. The basic idea is that the more diversified your stock portfolio is – the more different things the money is in – the less risk of losing money you can’t get back. On the other hand, if all of your money is in one company and it falls apart, you can lose everything. The ‘cost’ in stock investing comes from the fees you are paying to the brokerage you have your account with. Generally speaking, the higher the amount of active management, the higher the fees you will pay.
This is the problem with the idea of investment that most people have at the front of their minds. Most people imagine paying a financial advisor who will manage the fund’s allocation in order to make money by ‘beating the market’. But these active investors by definition cost more than passive investment, and carry more risk. After all, if they are picking specific stocks or sectors of the economy, they can be wrong and underperform the market too. In fact they will do this more often than not. Numerous studies show that few stock managers beat the market for years on end, and that’s what they would have to do to be worth it to you. Think about it like this – if you are paying a 1.5% fee, and the market goes up by 4.5% this year, then to do better than break even your manager has to get at least a 6% return. They have to beat the market year after year, because if they screw it up badly once or twice, they’ll have lost all their previous gains.
Common sense should tell us this isn’t possible even without the studies. The investors are the market. The market is the average of what investors are willing to pay for a given stock. So most of them can’t do much better than the average and half or more might do worse. Only a very small number of people would plausibly be able to outsmart everyone else, picking from the whole economy, all the time. If any. How much knowledge about the world would that take, and how much cunning? If these people do exist, they don’t handle the money of ordinary Americans for a couple percentage points.
But there is another way to go with stocks. That is index fund investing. This method just puts your money in a fund that is the whole stock market and lets your money rise and fall with it. This lets your money grow over time without the risk of betting the wrong way. It won’t net you big returns, but it won’t throw everything away either. The key here is time. These funds are meant to let money grow for years and decades. The fees are very low – usually only a few tenths of a percent – because you are only paying the broker for the overhead of their infrastructures to have the accounts, not to manage anything.
These require patience and realism. You won’t get rich quick, but if you put enough money and time in, you might get rich slowly. The hardest part for you will be to avoid the temptation to take money out when the market periodically goes down. You should just keep putting money in, month after month, year after year. I find it easiest to remember that the money isn’t real – it’s an estimate of what would happen if I sold the stock right now. But I don’t want to, so it doesn’t matter if it goes down in the short term. What I actually own is the shares themselves, and I still own the same number of shares when the market goes down as I did yesterday. From that point of view, a market downturn is just like a clearance sale to get more stock for the long term. It’s the perfect time to invest.
I prefer Vanguard for this because Vanguard is member-owned and pioneered index funds. There are competitors who now offer low-cost index funds as well, but they do it to compete with Vanguard, and would make it less good for investors if they could get away with it because they are beholden to shareholders.
In conclusion – if you have managed to start saving some money and are wondering what to do with it, you can’t go wrong by getting a Vanguard account and putting as much as possible into index funds as early as possible.