In “Learn to Invest from the Best” we set out to find a better approach to learn how to invest. Their first lesson is; Stocks are the best investment. But where is the time and energy to invest while you focus on family, career, education, and the other priorities in life? You can do less, make more, investing with funds.
It’s easy to start with funds for beginners, and it’s probably worth a lot more than you imagine.
Are a few hours of your time worth $50,000?
A few hours is about how long it will take to open a brokerage account and set up a fund investing program. Even $100 a month earning the average long term stock market return of 10% is significant.
That is if you don’t squander your greatest resource; time. If you are beginning, you have an estimated 40-year work life ahead of you. If you put your money to work alongside you, the power of compounding will work wonders.
The table below shows what happens to $100 per month with an average 10% annual return. Over the 40 years, you save $48,000 ($100/month X 12 months X 40 years = $48,000). However, compounding over those years increases that to $531,000. That’s a half million dollars!
The Opportunity Cost
Opportunity costs are the benefit or value of something that must be given up for something else. In this case, we’ll look at a year’s worth of delay in time before you invest just $100 per month.
On the surface, it may look like a one year delay costs $120 at most in lost returns ($100/month X 12 months X 1 years = $1,200 X 10% = $120), but it’s much more.
Some people believe it is the first year lost, but it is not, it is the 40th year that is lost. Compounding occurs for 39 years, not 40 years, so the opportunity cost is that last year of compounding or $49,374 in the table below.
Let’s use one more example because it is a critical point on wealth creation. Let’s assume investing is delayed five years to save $6,000 for a car down payment ($100/month X 12 months X 5 years = $6,000). The opportunity cost of that five-year delay is $172,159, the sum of the change in years 36 through 40 in the table above.
Add that opportunity cost to the price of the car, and it turns out to be an expensive car!
Of course balancing time, money, and priorities between competing demands is a common concern for all of us. You may still choose not to invest at this time. However, it will be an informed decision knowing the opportunity costs involved.
Do Less, Make More, Investing with Funds
There are times when you should do something and times when you should wait. Opportunity costs show how relatively small changes, like a one year delay out of forty-year time frame, can create significant impacts on your wealth.
So, where do you find the time to learn how to invest and study company reports, investment thesis, trends and ratios for hours on end? Fortunately, there’s an option to avoid this learning curve up front and the associated opportunity costs. You can start building wealth earlier; do less, make more, investing with funds.
Fund investors combine their money with others to purchase a range of assets to form a portfolio. The fund pools the investors’ money to buy different stocks.
However, like many things in investing, it can get overly complicated, don’t let it.
Funds invest in many types of assets, like bonds, commodities, real estate, and strategies. Plus, the number of mutual funds in the United States increased from 6778 in 1997 to 9356 in 2017 according to the statista while the number of publicly traded companies declined from 7322 to 3672 over the period. More funds than companies!
Let’s stick to our keep it simple theme, focus on the attractive returns of business ownership through stock and, sort through the noise.
You don’t have to be an active investor closely following individual companies to realize these returns. Funds are built for investors who wish to remain passive and they take little time to get up and running.
Professionals actively manage the funds and, others are managed with a computer-driven strategy. In either case you, the investor, are not actively involved and your money is diversified in a basket of stocks. So, you do less, make more, investing with funds and avoid the delays and opportunity cost of not investing.
There are two primary fund types: exchange-traded funds (ETFs) and mutual funds.
Exchange Traded Funds (ETFs)
ETFs trade throughout the day during regular market hours, just like individual stocks. They often require low or no minimum investments, and you can purchase as few shares as you wish.
The larger index Exchange Traded Funds are designed to track the performance of a stock market index like the Standard andPoor 500 (S&P 500). The fund purchases the securities in the index or a representative example for the fund investor.
The larger index ETFs have high trading volumes and lower expenses than Mutual Fund shares. The pioneer Vanguard ETFs has an average expense ratio of 0.11%, for example.
ETFs generate fewer taxable events and are generally more tax efficient than Mutual Funds because there are fewer taxable events that occur in them.
When you buy a Mutual Fund share, you own a stake in the Mutual Fund company and its portfolio of stocks. They hire investment managers to invest the pooled money from investors in particular stocks and try to beat the market.
If you buy Walmart stock, for example, you purchase part ownership of Walmart company, including its assets. When you buy a Mutual share, you are buying part ownership in the Mutual Fund Company, including its assets, in this case, a portfolio of stocks.
Actively managed mutual funds try to outperform their benchmark, or peer group, through research and experience on the management team. They tend to have higher expense ratios to pay for the research and expertise with an industry average expense ratio of about 0.6%.
However, fund costs can vary widely. In a Forbes article, “How Much Do Mutual Funds Really Cost?”, the author estimates disclosed costs (1.19%), hidden costs (1.44%), tax inefficiency (1.10%), and poor behavior (2.49%) could amount to as much as 6.2%.
The price of Mutual Fund share is based on its Net Asset Value (NAV). The total value of the stocks in the Mutual Fund portfolio divided by the number of the fund’s outstanding shares is the NAV.
Investors buy or sell (redeem) Mutual Fund shares after the market closes. That is because the funds use the closing price of the stocks in the portfolio at the end of each trading day to value the fund shares.
Most active Mutual Funds have minimum investment requirements in the range of $1,000 to $2,500. Lower minimums may be available in employer-sponsored plans or through the funds’ automatic investment plans.
Getting Your Money’s Worth
A scorecard from Standard and Poor’s reported that 92.2% of large capitalization funds lagged the Standard and Poor 500 Index fund over 15 years. Mid and small-size capitalization funds lagged their respective benchmarks at 95.4% and 93.2%, respectively.
The chart below clearly illustrates how you can do less, make more, investing with funds over a wide range of investing time frames.
There are active investment managers that outperform the stock market, but it takes research time to find them. If you don’t have the time, your chance of finding one of the market outperformers is about 5% or a 1 in 20 chance.
The message is clear. Most investors should “settle” for market performance (averaging about 10% per year) and purchase low-cost index Exchange Traded Funds that mirror major stock market indices like the S&P 500.
Avoid The Activity Trap
Even the investor who is fortunate enough to find a fund that outperforms the market on average underperforms the fund itself. As discussed in The Rational Investor they try to chase performance and time the market.
Ironically they are active investors in a passive investment strategy (the fund). Any investment horizon needs to be long term, don’t fall into the trap of overactivity and underperformance. Do less, make more, investing with funds and let compounding over time do the work.
Summary and Conclusions
What can you take away from this?
- Investing in funds can free up the time and energy to focus on family, education, career, and other priorities in your life.
- A faster road to investing through funds avoids the enormous potential opportunity costs of delays.
- Funds offer an easy way for investors to buy a diversified portfolio, lower risk and greatly simplify their investment plan regardless of portfolio size.
- Most investors will do best with low-cost Index Exchange Traded Funds that mirror a major stock index like the Standard and Poor’s 500.
- They help prepare for investing on your own someday, if you wish, by following the performance and strategies of funds and their professional managers.
- You can do less, make more, investing with funds.
Still, you may find later, as I did, that you enjoy investing and want to become more involved selecting some or all of your individual stocks. Either way, funds are a great place for the new investor to begin.
- Morningstar Service
- Kiplinger Mutual Fund Finder
- U.S. News and World Report The Best Guide to Mutual Funds
- ETFs vs. Mutual Funds: Which is Better for Young Investors?