Conventional wisdom says that you should never invest in something you do not understand. The problem is that advice leaves most people with nowhere to start. I prefer to start now, then "learn by doing" to understand my investment. With that advice in mind, let us take a deeper look into investing in an S&P 500 index fund.
In this case, we put $1,000 into an index fund at the start of the year. Today, we only have $900. Did we make the wrong choice? Did we pick the wrong fund? Did we invest at the wrong time? Or, is this all a scam?
First, it is important to understand what happened to our money. We put $1,000 into an index fund. At that point, the index fund was valued at $50 per share. This $50 is its "net asset value" (NAV), which technically means the weighted value of all the stocks in the mutual fund on that day's closing, but effectively, it is the price per share of the mutual fund. Therefore, when we put in $1,000, we bought 20 shares of the index fund (i.e., $1,000 / $50 per share = 20 shares).
In this example, the index is down 10% so far this year. Accordingly, the NAV of the index fund falls to $45. Now, the value of our 20 shares is only $900. Overall, our investment is down $100, because the index is down 10%. The index closes anew every weekday (excluding holidays) and the NAV is calculated every day after the index closes.
Because the S&P 500 index will replace failing companies with more promising companies over time, the index is setting itself up for better success in the long run. Accordingly, the NAV of our index fund will rise over time. Periodically, our index fund will also distribute dividiends and capital gains (always be sure to have those reinvested in your fund!) so if the fund paid a dividend of $2.25 per share, then we would gain another share (i.e., $2.25 x 20 = $45 = NAV of index fund).
Let us jump a bit ahead: the economy suddenly has had a strong turnaround, pushing the index (and our index fund's NAV) much higher. Our index fund's NAV is now $60, and we have 21 shares (20 from our $1000, plus 1 share from reinvested dividends). Without our doing anything else after opening & funding the account with $1,000, our investment is now worth $1,260. Over time, these $260 gains can double, triple, or increase tenfold. Obviously, it varies based on the number of shares you own.
Now, have you ever heard someone say “I lost all my money in the stock market,” so ... what does that even mean?
In short, it can mean a few things – but it would not mean they put $1,000 into an S&P 500 index fund and lost all of it. If the person is not simply embellishing, then they might mean that they lost all of their gains above their initial investment as the stock market dropped. That can happen. It most likely will happen when you start investing. It happened to me between starting in 2003 and the “Great Recession” in 2008-09. Thankfully, I spent 2006-07 with regret for not putting more money into the market in 2003, so when the Great Recession happened, I saw it as buying shares at yesteryear’s prices today. That is a rare opportunity, and as such, it is long gone now. But today, the market is falling from its 2021 peaks, and it couple drop below what it was through most of 2020. The market’s initial reaction to the global pandemic in mid-March 2020 was a major depression (somewhat different than the type of major depression many people experienced at that same time) so I doubt that the current trends will match the lows of 2020.
Regardless, this decline in the market is an ideal time to begin investing. Putting $1,000 in right now will buy more shares than $1,000 would have bought at the end of last year. As the NAV increases and the fund reinvests its dividends, the value of the investment will increase exponentially.
