As you get closer and closer to graduation or start to make a decent income, you will find people that appear out of nowhere who are willing to manage your money for you. Most of them are well intentioned and are great people. However, some of them will offer a lot of promises and will claim they have a proven technique or formula to guarantee the best returns. Others will claim that they can beat the market. When you start to hear this, you need to run far away from these people.
I am not knocking financial planners, there are a ton of lessons that they can teach you, and many of them can help set up other important aspects of your financial health. Items such as disability insurance, life insurance, estate planning, umbrella insurance, etc. are all essential components of a complete financial plan.
In terms of investing, time and time again the studies show the use of index funds will beat hedge funds and those who claim they can time the market almost every time. Furthermore, the use of low-cost index funds will significantly reduce your expenses to invest. The two things that you need to ensure so that you maximize your long-term returns are: maintain solid gains year after year and minimize your expenses.
A lot of these money managers who charge you for their stock picks, that barely keep up with the market, will charge you fees that significantly impede your ability to accumulate wealth. For example, let’s say you are starting out and your financial advisor gives you an introductory rate of 1% of all assets under management. That doesn’t sound horrible, 1% of $10,000 is a $100, that is a steal of a deal especially if you have no idea what you are doing! However, the actual fact is that they usually have a minimum that varies from $500-$1000. Furthermore, 1% of $100,000 is now $1000, 1% of $500,000 is $5000, and as you begin to increase your wealth further, your management fees will also increase. This 1% does not get reduced in a bear market, when your assets are losing money. Even during these times, you will still need to fork over your management fee. This is on top of all trade transaction fees, commissions, expense ratios, and other fees associated with investing itself. Very quickly, you will start to realize that whatever gains you are supposed to realize are quickly diminishing. Furthermore, a lot of these money managers will preferentially select securities that are owned by their managing firm. These securities have very high expense ratios associated with them, that further chip away at any potential gains that you could have realized. Additionally, they confer no additional benefit in terms of market performance compared other options with lower expenses.
Warren Buffet, Jack Bogle, and many other top-tier investors have said time and time again, low-cost index funds are the best way to invest in the market, diversify, and minimize your expenses. Vanguard was the pioneer in creating these low-cost index funds and ETFs that have expense ratios that are 10ths of percent, now many other brokerage firms offer the same thing. The most common index fund that is referenced is the S&P 500 Index fund. VOO is the ticker symbol for the S&P 500 index ETF. ETFs are easier to trade as they act like stocks, versus index funds which trade at the end of the day and require a day or two in order for your funds to clear when you sell them.
I like the S&P 500 index fund ETF, because they represent the top 500 US publicly traded companies. Companies that start to do poorly are phased out and companies that are doing well are phased in, in order to optimize the fund’s performance. The securities listed in the S&P500 are fairly well diversified, as in you have a decent proportion of companies representing various sectors such as communication services, energy, health care, financial services, real estate, utilities, etc. However, the index is heavily weighted in the information technology sector (26.4% of the fund consists of companies in this sector). If there is one fund that I would recommend to get started investing with, VOO would be that fund. Keep in mind that this is a long-term investment and there will be ups and downs in its performance. That being said, depending on what you read, the S&P 500 has averaged a rate of return between 8% to over 10% annually since its inception.
There are other popular index fund ETFs such as the total stock market index (VTI), Russell 2000 ETF (VTWO), Total International Stock ETF (VXUS). There are also target retirement funds that a lot of brokerage firms set up. These funds are designed to change your risk profile from being heavy on stocks to more heavily weighted in bonds as you age and get closer to retirement. The idea is that stocks are more risky and volatile than bonds, which are perceived to be more steady and reliable. As you age, your portfolio will shift more to bonds from stocks in order to ensure that you have a stable nest egg and that your investments are in more stable and less volatile funds.
What about trading individual stocks? Although this is riskier, if you are someone who keeps in the know about how companies are doing, can read financial statements, can follow how the market is performing frequently, then this is a great option.