You Must Know This Before Investing in Index Funds or ETFs
Source: Google Finance
What is your holding period?
Index funds and ETFs are an excellent way to compound wealth and generate passive income.
However, if you don’t understand the recommended stock holding period, you can lose money in the stock market.
Studies show that holding an S&P 500 index fund is consistently profitable over ten-year spans.
The catch is that your investment portfolio will fluctuate up and down depending on economic conditions.
Therefore, there is a chance that you will lose money if you do not hold the fund for ten years or longer. If you need your money sooner, you have other investment options.
Investments you can make with a short holding period:
Short-term bonds (ETF examples: VGSH and VCSH)
Money market funds
CDs
High Yield Savings account
These short-term investments won’t give you a great return, but they are better than letting your money sit in a traditional savings account.
How much risk are you willing to take?
Did you know that if you invested in the stock market in 2007, at one point, you would have lost 55% of your portfolio?
For example, if you had $100,000 invested, your account would have dropped to $45,000 at the lowest point..
Source: AndCo Consulting, using data and information derived from Bloomberg.
If you cannot emotionally deal with a 50%+ drawdown, you will struggle to invest in the stock market.
However, if you are willing to hold an index fund for a decade and can stomach drawdowns, you will do well in the stock market.
What do you want to invest in?
There are many assets you can trade in the stock market. For example, you can invest in gold, real estate, energy, and more. The stock market is a great way to efficiently gain exposure to various types of assets and commodities on top of public companies.
What type of fund should you invest in?
There are many different funds available for you to invest in, so I will quickly break down the differences.
Index fund vs. ETF
An index fund only updates prices at market close.
You can place orders to buy and sell anytime, but they won’t fill if the market is not open.
Index funds are great for passive investors who never want to check their portfolios.
ETFs trade the entire time the stock market is open, and options are usually available to trade on them. They trade just like a regular stock.
If you follow the stock market, ETFs allow you to buy options to hedge or see how your portfolio moves throughout the trading day.
Mutual funds vs. index funds
An index fund is a type of mutual fund that follows a stock index like the S&P 500.
A mutual fund can be an index fund or an actively managed fund that charges a higher fee.
REITs
Real estate investment trusts (REITs) own a bunch of real estate properties and are available for you to buy on the stock market.
REITs must pay 90% of their taxable income to shareholders, making them a great way to invest in real estate passively.
How to pick the fund with the lowest fees
Historically, investing in the indexes has been the most profitable compared to most actively managed funds.
To find the lowest fee ETF or index fund, you must first make a list.
You can Google S&P 500 funds, dividend funds, and REIT ETFs to compare.
Write down all the tickers that you find.
Next, Google the expense ratio for each fund and see which is the lowest.
You can also look up the performance of the fund to see which has provided the most return.
What is the best S&P 500 ETF?
I’m a big fan of VOO and SPY.
The ticker symbol VOO is Vanguards S&P 500 index fund and has the lowest available expense ratio at just 0.03%.
The ticker symbol SPY is the most liquid S&P 500 ETF, which is great for more active investors. The expense ratio of SPY is 0.09%.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #029
