Face it. The general population, including myself, is mostly clueless when it comes to the stock market. Most of us don’t spend hours every day watching the charts and researching the goings-on in all the major companies.
That doesn’t mean we can’t invest in the stock market. It just means we have to know our circle of competence, admit that we’re not experts and play it safe.
Investing in an index fund is the safe way to invest in the stock market. In this video, I explain why.
HOW TO INVEST IN AN INDEX FUND
An index fund spreads your money across the top companies on the stock market. Each index fund is based on a stock market index, such as the S&P 500 in the United States or the ASX 200 in Australia.
You can go to Vanguard to open an account with an index fund. Vanguard is the oldest provider of index funds. It opened the world’s first retail index fund in 1976, based on the S&P 500, and is still widely popular.
When investing in index funds, you’re not betting that a particular stock will go through the roof. The only bet you’re making is that the stock market as a whole will do well.
That’s a fairly safe bet to make, too. Over the last 50 years, individual stocks have gone up and down, but the stock market as a whole has done well. Vanguard’s index fund has averaged a return of 11% since its inception in 1976, matching the return of the S&P 500 over the same period.
Be realistic, though. You may not see an 11% return in your first year. Maybe you start investing when the stock market is experiencing a slump. That’s OK, as long as you treat it as a long term endeavor.
Over the next 10 years or more, the short term ups and downs will average out and you’re likely to see those returns.
USING DOLLAR COST AVERAGING WITH INDEX FUNDS
Sticking to index funds will keep you safe enough, but you can actually take it one step further.
If you put all your money into an index fund when the market is at its absolute peak, that’s not good. Your money would immediately start to lose its value and it may be difficult to recover.
Ideally, you’d buy in at the trough, and then the only way is up. The problem is that we’re not experts and we don’t know when the peaks are going to happen and when the troughs are going to happen.
The best compromise is to use dollar cost averaging. With this method, you invest the same small amount every month, rather than a large amount all at once. Then, the ups and downs will average out and you’ll be buying your stocks at the average market price.
I use dollar cost averaging with my Australian index fund. I don’t know what’s going to happen in the Australian economy in the next 6 months. Even if the news says it has a terrible outlook, I still invest the same amount each month. This way, I protect myself from buying in at the worst times.
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