Another important term to know in investing is Index funds. An index is a group of stock or bonds based upon a certain criteria. For example, the most popular index in the world is the S&P 500. The S&P 500 is a group of the largest 500 companies listed in the United States. So when you buy the S&P 500, you own a part of Starbucks, Google, Apple and 497 other competitive powerhouses.
Index funds have become extremely popular. They have much lower fees than an actively managed fund and you don’t need to second guess them. If the entire market falls because of a recession, no problem, you keep holding the fund, buy more if you can and wait for it to come back. But if you have an actively managed fund and it falls more than the market, is it temporary? Should you sell? It becomes a headache.
Next up, mutual funds and exchange traded funds (ETFs). The biggest difference between buying an index in mutual fund or ETF format is that mutual funds are typically better for smaller, more frequent purchases as you can get ones that don’t have trading fees. ETF’s are typically better for larger or infrequent purchases as they trade on the stock market and you pay a trading fee, but they are typically less expensive.
So, we now know we’re going to invest in equity and bond index funds in either mutual funds or ETFs. Next, who do you invest with?
Taxes will also eat your return so be sure to invest in a 401(k) and/or a Roth IRA. In Canada, invest in RRSP/TFSA’s first.
I’d like to finish with a warning. Take everything that you see with a grain of salt. The finance industry is enormous and companies are willing to spend lots of money to get a consumer. Lots of slick salesmen are out there knocking on doors hawking expensive products. If you see a yearly fee in the 1.5%+ range that is ridiculous. If they charge you a large percentage fee when you put your money in or take it out, that’s crazy. Ask how the person you’re dealing with is compensated. It’s your money, you’ve worked hard for it, don’t let someone siphon it away!
While the 90/10 equity/bond split may not be right for you (Warren Buffett has a lot more money so his family can weather great storms), you should take comfort that one of the world’s best investors believes in index funds and Vanguard.
You're through the notes, so if you haven't already, put it into action. Refer back to the notes. Ask questions. And join the newsletter! We'll send out an occasional note to inspire and keep you straight on your journey to financial independence.