Knowing how to invest in stocks is an important step you can take to achieve financial freedom. Investing with index funds is one of the best methods for the average investor to invest in stocks. It’s a statement backed not only by research but by the stories of those who have retired early. This is a short guide on what you need to know for index funds investing.
Successfully choosing individual stocks is difficult. Even people who have studied them for all their lives can’t beat the market. In fact, 90% of active fund managers underperformed against their benchmark index over 20 years.
In a period where the stock market is crashing, the argument is that there is special value to be found in hand-picked stocks. The problem is that the above finding is consistent across all asset classes, cap sizes and domestic or international markets.
Chasing winning stocks is exciting and can be fun. If you are a true investing geek but it’s a little like gambling. In reality, successful investing is often:
Lowest costs
Maximum returns
Minimum taxes
No effort
In short, index fund investing.
Disclaimer: This is not financial advice and you are responsible for your own investment decisions. When investing capital is at risk. This article may contain affiliate links.
What Is An Index Fund And How Does It Work
Investing with index funds is straightforward and you don’t need to know a great deal. So, what is an index fund? An index is quite simply a basket of securities within an asset. For example, the FTSE 100 is a collection of the 500 biggest companies in the UK.
If you were buying shares individually you would need to buy one share in all 100 companies. Say you had £100 to invest. To mirror the FTSE 100 you’d have to calculate out the fractional weighting of your investments. To do this you would manually have to calculate split your £100 by each companies market cap and their weighting in the index.
An index fund does this all for you. You get all the benefits without any of the work. You can then buy into a fund of index funds, which captures multi-indices from around the world. Index funds are passive in nature. Rather than you or the fund manager buying and selling stocks to “beat the market”, you are the market. By tracking the benchmark index, you beat 90% of the fund manager out there.
What Is The Best Index Fund For You?
Not all index funds are made equal, so which index fund should you buy. Index funds vary by region, market cap, and asset class. Which means that you can buy bonds in the US or stocks in Brazil. Equally you could buy into a Real Estate Investment Trust (REIT) which buys stocks in the property sector.
Many savvy investors often recommend a fund that tracks the FTSE Global All Cap index. This tracks over 7000 equities around the world and is one of the most diverse funds you can invest into. You can access my the 8 index funds that make my shortlist here.
Other investors recommend a more balanced approach and would direct you to a multi-asset allocation approach. This would diversify your investments across a range of different assets. The fund may combine, Vanguard Total Bond Index Fund with Vanguard U.S. Equity Index Fund. This is is a more balanced approach to investing. Download my 8 balanced funds here (US based here).
How I Selected My First Index Fund
Investing can be overwhelming. Selecting an index fund without a sense of process doesn’t sit well for many people. When I started investing, I definitely felt this way. That’s why I often direct friends and family to the Fidelity Fund Navigator. That’s because you might not be entirely convinced by a completely passive index investing approach.
Depending on if you select cost-focused or expert-focused the navigator may direct you to a fund such as the as the Fidelity Allocator World fund (my current fund). Which is an active index based approach with a strategic element. Which is like a autonomous vehicle with someone behind the wheel.
This means that if the fund manager sees an undervalued area of the market they can invest into it. For example, I recently highlighted that Small and Mid-Cap stocks are potentially undervalued. A fund such as the Allocator World fund could increase it’s weighting in those stocks. I’ve already observed this with the fund increasing it’s weighting into the iShares Glb Prpty Secs Eq Idx (UK) L Acc.
Balanced Index Investing Funds
Equally, the navigator can recommend multi-asset funds such as the Fidelity Multi Asset Allocator Growth Fund which has a mixture of stocks and bonds (circa 40%). This is fund originally recommended to me when I was a more hesitant investor.
However, if you choose the more expert-focused approach you may be directed to the Fidelity Multi Asset Open Growth Fund. Which at the time of writing is currently taking long and short positions on different stocks, bond and currencies. Whilst the Fidelity Allocator suggest ahead in growth, you can see it’s much more volatile, where as the multi-asset funds offer a much more slow but steady journey. The below is based on a £1,000 starting investment.
Is 2022/23 A Good Time For Investing With Index Funds?
You can never truly time the market, investors that do usually get burned. At present, we’re in the midst of a bear market. Rising inflation and interest rates and looming recessions threaten global markets.
One investor will tell you we’re at the bottom and stock price declines are already priced in. Another will tell you that the market can crash by a further 40%. Knowing how to invest to hedge against market euphoria and dysphoria is key.
Bear markets can be a great time to invest because you are buying stocks at a lower price. The problem is that you may have to suffer further price declines if the market continues to fall. This is why it’s necessary to invest in a fund and asset allocation appropriate to your time horizon.
< Explore: Will The Stock Market Continue To Fall & Should You Sell-Off Now? >
How To Avoid Losing Money In The Stock Market
This can help you mitigate risk in your investment portfolio. New investors will never find a good time to invest but there is a silver lining. There are also a number of things to consider when investing into index funds:
Maintain a low cost base: As a rule of thumb I stay away from fund managers charging >1%.
Know what index your fund is mimicking: Reviewing the portfolio section of a fund fact sheet is key to ensuring you understand what you are investing in.
Don’t check your investments too often: The more you check, the more you will see a loss in your portfolio.
Automate your investments: That way you don’t be tempted to try and time the market.
Maintain an appropriate asset allocation for your risk temperament and time horizon. Should you be entering retirement you can also download my 5 Defensive Focused Retirement Style Funds.
Trackbacks/Pingbacks