My first real introduction to investing was back at the end of 2008. It was a big year. The real estate market was crashing. The world was in a financial meltdown. And I was a cheeky 20-something who decided it seemed like the perfect time to make a quick buck in the stock market. I started slowly by investing $2,000 and within a few months, I had dumped most of my savings (around $10,000 at the time) into a handful of investments.
After picking a few stocks and watching them improve over the next year, I naturally figured I was the rain man. I couldn’t lose. This was easy money. And soon I’d retire on an island in the Pacific on all my stock market winnings.
Jordan was also in on the game. We’d read business articles, comb financial statements, and ponder analyst reports. Yeah…we had no idea what we were doing. But we thought we sounded smart.
When I saw Jordan making a killing on the stock from solar panel company Sunpower, I wanted in. I jumped in on the new hot business and waited for my payday (remember this was 2009 and solar panels were just going mainstream).
How could I lose?
Spoiler: I lost. It was cruel. The stock dropped to nearly nothing. And I was crushed.
At this dark moment, I was pretty much put off by investing. I didn’t take my money out of the market but I stopped tracking it, stopped buying stocks, and stopped dreaming about my retirement on an island in the middle of the Pacific.
Who had time to play the market anyway?
A few months later I heard about the index fund. These were not new, but they were new to me. I was caught up in the sexiness of stock picking and while I’m sure somewhere in my financial research I had come across index funds, they seemed boring to 24-year-old Erica so I skipped right over them.
But when I heard Warren Buffett championing the index fund I decided they were worth a second look.
What is an index fund?
An index fund is a portfolio of investments that are constructed to match different market indexes. For example, the S&P 500 is an index of stocks from the 500 largest companies in the US. Rather than investing in just a few stocks that are part of the S&P 500, you can invest in an S&P 500 index fund, which gives you a sliver of the entire S&P.
If you invest in a total market index fund, again instead of picking a few stocks in the market, you’ll be invested in a broad number of companies that will reflect the performance of the total stock market.
Why invest in an index fund?
Spreading out the risk is the name of the game when it comes to long-term investing. An index fund is an easy way to spread out the risk because instead of investing in a few companies, you’re invested in a lot of companies. They also have extremely low fees, which means you get to keep more of your earnings.
What’s the downside?
Just like any other investment, you’re exposed to risk. If the market declines, and it always does at some point, your investment will dip as well.
What if I had invested in an index fund in 2009?
I’m all for admitting my mistakes because I want to make sure that we all can learn from them. So I decided to do a little math.
I looked at the stocks that I bought in 2009 and compared their performance to the Vanguard Total Stock Market ETF. This is their basic fund that matches the performance of the entire US stock market.
While most of the stocks I bought in 2009 were winners, I did have one loser. Thanks, Jordan. But overall my portfolio went up. Since I was a winner overall, is there really any difference between what I earned investing on my own and what I would have earned if I invested in an index fund that was set to track the market?
*Note: before moving into the actual returns seen over this eight-year time period, it’s important to remember the timing here. The returns shown are so large because I’m tracking from the deepest point in the recession when prices were extremely low to present day, in an arguably inflated market. These returns are not even close to typical long-term returns. This just happened to be the time period I was starting to dabble in investing and it was arguably the opportunity of a lifetime to get such massive returns. Which I did not. This is really for illustration only, to make fun of my 24-year-old wannabe day trading self.
The $10,000 I invested in 2009 into 6 stocks would be worth a whopping $13,135 today. Notice I say would be worth because I did eventually sell these stocks and abandon the individual stock picking strategy.
Had I taken that $10,000 and put it in the Vanguard Total Stock Market Fund, it would be worth $29,547 today.
Let that sink in. Would you rather have $13,135 or $29,547?
Taking a look at this today totally knocked the wind from my sails. For years now I’ve been giving Jordan a hard time about suggesting the one stock where I lost money. I blamed my lackluster portfolio on that loss.
It turns out, we were both wrong. I should not have been playing an amateur game of Boiler Room because even without that loss, my portfolio performance was nowhere near what the return would have been from an index fund. Because this index fund tracks the market, my returns would have more closely matched the entire market returns. Instead, I concentrated my money in 6 stocks, 5 of which increased in value but didn’t increase as much as the entire market did during the incredible boom time.
Now for all of my nerdy readers out there who are asking, “but what about the fees?”, I know. I’m not including the 0.04% expense ratio of the ETF. We’ll get there, but we’ll talk all about fees in another article. My brain is tired from realizing how much money I didn’t make all those years ago.
Should you run out and invest your money in index funds after this? No. Jordan and I (along with our BFF Warren Buffett) invest in various index funds. We like them. They work for us.
But we still do our research, make sure we pay appropriate fees, take a balanced approach to investing, and understand that this is a long-term plan we have going on so we feel comfortable weathering the ups and the downs.
While we want the big life today, we also want to make sure we can have the big life when we’re in our golden years.
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