Fabulously Broke’s Retirement + Investment Primer – Pt. 5: The simple joy of the index fund

DISCLAIMER: This is totally from my own personal experience and point of view. I am not a professional financial advisor, nor do I claim to be one. I’m just a girl trying to make it through the world and pass on what I’ve learned so far from reading, talking to others, and by trial and error. I’m also purposely keeping it simple.

PART 5: THE SIMPLE JOY OF THE INDEX FUND

My honest opinion of what the best mutual fund is the index mutual funds aka “index funds”. Historically, the average of the stock market (aka the index mutual fund) has returned a decent interest percentage, has a low MER % (as explained in the previous Part), and consistently beaten over the long run most handpicked investment portfolios. You may have people coming to you saying: “Hey FB, if you pick me to manage your money, I can bring you at least 22% returns a year. Guaranteed! Look at my portfolio, I’ve returned 18%-22% every single year, for the past 2 years“.

Don’t get blinded by the potential dollar signs (aka “the sizzle on the steak”) that they’re waving at you, because you have to ask yourself “But how long can that last?” A good streak can’t last forever, is all I’m trying to say. They cannot, humanly, guarantee and pick stocks every single year that earn 18% – 22% annually. It just isn’t possible.

Why?

Because the stock market is based in reality and in the unpredictable, very human world. Nobody could have predict that gas prices would shoot up so high in the past 2-5 years (and therefore make gas companies like Exxon Mobil extremely rich), because no one could have truly predict Hurricane Katrina, the war, the tsunami that rocked Asia or any of the other natural disasters. No one can predict what is going to happen, and for a person to realistically and consistently pick the top performing stocks every single year, they’d need to be able to be psychic and predict the future.

So like I said, it’s just not possible.

What these people are doing, is essentially gambling your money. They’re getting an euphoric rush, playing the stock market, and using YOUR money to do so. What’s going to happen if they end up losing all of your money? They’re just going to say: “Oh well, the chips are down. I’m sorry, but I never said I definitely knew what was going to happen to my portfolio next year. Who knew that Natural Event A would’ve happened or Natural Event B would’ve done so much damage? I didn’t. I’m only human. I’m not psychic.”

Exactly.

That’s why I’d rather invest in index funds and get a bit of everything. If one industry goes down or does badly, because whenever an industry goes down, another will surely spark up and do much better as a result.

There is more substantative, and quantitative evidence to support index funds, and you can read the IFA 12-step index fund book here. It’s changed my view on investing and frankly, made it easier.

Here’s some (fairly) solid proof that anyone can manage their money and do well. I suppose you’ve already heard about the $1 million dollar waitress by now?

Waitress is $1 million stock guru
A woman who has never bought a share of stock is the winner of CNBC’s stock-picking contest. But she doesn’t plan to risk the prize money with the same investment strategy.

Mary Sue Williams, an Ohio waitress who said she has never bought or sold a stock in her life, on Friday won $1 million as grand prize winner of CNBC’s Million Dollar Portfolio Challenge.

It was a fairy-tale ending for a contest wrought with drama and controversy.

Williams, 46, has been a waitress for 20 years and was a welder before that. She bested a field of 375,000 entrants that included thousands of financial professionals who entered with Ivy League degrees and complex trading models. Weekly winners received $10,000 each.

In a profile of her as a finalist, the St. Clairsville, Ohio, woman told BusinessWeek that she had never even paid much attention to the markets before signing up for the challenge.

“Part of this was luck,” she says. “A lot of it was a gut feeling, some eenie, meenie, minie, moe, and common sense.”

Williams and her husband, Mark, entered the contest at the urging of his mother.

Mark Williams but didn’t make it out of the contest’s 10-week first round. His wife followed a straightforward strategy of researching companies that were about to announce their quarterly results. She figured that companies reporting earnings were the most likely to see big moves.

‘They might learn something’
To pick specific stocks, she used the Warren Buffett approach: Invest in what you know. “I was looking for companies that had something to do with my life,” she says. That led to some of her most memorable picks, among them lubricant manufacturer WD-40 (WDFC, news, msgs) and Crocs (CROX, news, msgs), best known for its sandals.

…..

CNBC announced June 15 that it had hired Stanley Sporkin, a former Securities and Exchange Commission enforcement chief and federal judge, as well as computer firms Symantec (SYMC, news, msgs) and Neohapsis to investigate allegations of wrongdoing. A few top performers were suspected of exploiting a loophole in CNBC’s trading software to inflate their returns.

And voila. If she can do it (not that I’m saying that she’s stupid, on the contrary!) then anyone can. Just use Warren Buffet’s investing style and invest in what you know.

Now back to index funds: I also don’t advocate putting 100% of your money into index funds. This is just foolishness to put your eggs into one basket. I’d suggest maybe 50%-80% of your portfolio in index funds if you’re willing to invest in the long and very long term (meaning 30 years to 40 years), and you’re willing to weather the storms of the stock market. If you’re not, then adjust it to what you feel most comfortable with.

Hey, it’s your money, not mine. Only YOU (and your significant other) make the decisions about what you both want to do with your money.

Think about it in another way. The first stock exchange in the U.S. was founded in 1790, and then the NY stock exchange in 1817. It started quite small didn’t it? How much does the stock exchange trade now? Billions. Even though it didn’t seem like it was doing well before, and growing slowly, it was still growing, and still gaining. Why? Because companies keep making money, they keep spurring on the economy and creating value. This added value is then perceived in the stock market, and stocks go up and go down, and new companies enter, and increase the value and innovation of certain industries, which in turn spurs on competition, and companies gain more value, etc. But the key is that the stock market as a whole always grows. No matter how slow or how fast it grows, it still grows.

So with my personal opinion out there on the web, you can (and should) choose whatever robo-advisor floats your boat. If you think another one makes more sense, by all means go for it. Just keep in mind the profit-skimming MER 🙂