 |
| NONE OF THIS IS ACCURATE! |
Additionally, I have been planning to get a better view of the real American economy and understand people's relationship with money this year. Too many people believe the stock market is rigged in a way that proverbial wolves end up concluding that inaccessible grapes are sour. To that extreme, the media has reported that more than half of Americans have less than $1,000 to their name (determined by the responses of 518 people over 18, in reality).
Amid lotto fever, the above meme spread on social media -- and people immediately protested the calculations, but honestly, I felt the logic was equally invalid! As Dr. Robert Anthony hypothesized in his book The Advanced Formula for Total Success, "if we divided all the money in the world equally, in a short time the rich would be rich again, and the poor would be poor."
In anticipation of providing a needed service, I wanted to prepare a quick tutorial about investing for those who either tell me that they do not trust the stock markets or that they want to start investing but they literally do not know how. My hope is that, while the market declines, I can convince a few how investing can benefit them. I know it works because when an old friend got her first full-time job with benefits, she invited me to lunch to explain to her how her 401(k) worked. I told her (more or less) the following, and a couple years ago, she was praising me at a house party by saying that I was the reason for her financial stability, adding that she even bought her first car with a loan from her 401(k). That said, one of the most important things to understand about investing is the product in which you invest. The markets are always in motion, so understanding how the product works is important to avoid pitfalls like performance chasing or the quintessential "buy high/sell low" folly.
WHAT IS STOCK?
Stock is a certificate of ownership in a large corporation. You can buy shares of stock in many of your favorite brands: Amazon, Netflix, Starbucks, Chipotle, Disney, etc. As an owner, you would share in that company's prosperity. You are a fractional owner though, so you will get a fraction (minuscule amount) of their profits.
WHAT IS THE PROBLEM?
If you invested all of your available money into a single company, then you would have no impact on that company itself, but all of your financial welfare would be solely reliant upon that company. That company may not do very well in a given year, and even the strongest brands can lose acceptance by the public (such as K-Mart, Blackberry, McDonalds by large, and potentially Subway now).
WHAT CAN WE DO?
One solution is, if you and I mutually pool our money, we would have twice as much money together as either of us alone. Now we can buy into two separate companies to diversify our reliance on a single company for our financial well-being. The likelihood that both companies would fail is substantially lower (at least half). Add additional people to the plan, and that likelihood decreases even further.
WHAT IS A MUTUAL FUND?
A mutual fund is essentially that pooled concept: thousands or even millions of investors pool their money together to benefit from a shared, diversified portfolio. That pooled bank is large enough to put some of the money toward hiring a professional money manager to make the investment decisions who brings in the know-how and is paid to research the companies soundly.
Although there are countless mutual funds for a variety of markets in reality, the focus of this entry will stay within the equity (stock) market.
WHAT IS THE PROBLEM?
Historically, the economy has been going up, not just in recent years but for the past several decades. When trading individual stocks, it is said there’s a loser for every winner. All things equal, you stand to lose as much as you gain by trading in stocks, but if the economy itself continues to prosper, the investments would typically increase universally.
WHAT CAN WE DO?
If the economy is steadily increasing over time (such as 15-20 years), then that increase should suffice for most novice investors. Besides, if it is said that there's a loser for every winner trading in the stock market, then even selecting professional money managers is as risky as selecting the stocks themselves. Therefore, John C. Bogle pioneered the concept of pooling money into a mutual fund without hiring a money manager.
WHAT IS AN INDEX FUND?
An index fund is a mutual fund that merely mirrors a major market index without a hired manager. Consider the S&P 500 Index for example, which tracks 500 of the largest companies in the country today. When one of those companies falters in its performance, whether by losing money or just not making as much as other companies, it gets replaced by a company that, for sake of simplicity, was ranked at #501. As that happens, the index funds will sell the stock of the failing company and buy stock of the new company, so that the index fund itself will continue to mirror the index, owning the same 500 companies in the S&P 500.
WHAT IS THE PROBLEM?
The economy does not always go up, so when the index falls, its index fund should decline as well. Also, the grass will be greener in some (but not all) other pastures because actively traded stocks may increase more (or decline less) using complex financial strategies with successful traders (money managers). The theory that there is a loser for every winner in a trade remains though, so the over-performance of any trader will cause another trader to under-perform.
WHAT CAN WE DO?
If the performance of the economy itself is enough for you, then investing in an index fund may be the right choice. There will always be noise about how much more money you could be making in another fund, but that additional return is almost always accompanied by an even higher risk than the reward.
Typically, the only people who refute the merits of index fund investing are those who are selling a more expensive investment (or those who have recently bought into such an investment).
Typically, the only people who refute the merits of index fund investing are those who are selling a more expensive investment (or those who have recently bought into such an investment).
No comments:
Post a Comment