The Takeaway: How much you invest is not the most important factor to building wealth. It’s that you invest at all, because time -- and consistency -- work wonders.
If you harbor big dreams, such as retiring to a life of travel and hobbies; buying your forever home; or leaving an inheritance to your family, here’s my message to you: invest, invest, and keep investing.
Living out your dreams might be expensive, but I believe most people can build the kind of wealth it takes if they invest consistently in stocks and bonds (and possibly other assets, like real estate, but that’s a lesson for another day).
First, you have to let go of two myths about investing:
- That you need a lot of money to start
- That a complex strategy is better than a simple one
If you’ve covered your bills this month and have $10 to spare, you’re in a position to start investing. A workplace retirement plan, such as a 401(k) or 403(b), is the optimal place to begin. These accounts shelter your investment profits from taxes until you retire, supersizing your returns.
Compare the Best Savings Rates
Don’t have a workplace plan? Check out IRAs or taxable brokerage accounts, available through a number of online brokers and robo-advisors where you can invest with as little as $5. The right type of account for your goal will depend largely on the timing of it.
When it comes to picking investments, just keep it simple. I, like many other financial planners and economists, suggest holding the majority of your portfolio in passive index funds or ETFs, that are designed to mimic the returns of a broad-based index, like the S&P 500. You’ll get diversification and you won’t have to pay a professional for it -- or stress out picking stocks yourself.
There are index funds that track bond markets, too. Bond returns are more predictable than stock returns, so investing in them alongside stocks can smooth out the volatility you're sure to experience over decades of investing.
There are still fees associated with passive index funds, but they’re far lower than other investment options. Industry data shows that, on average, stock index funds charge an expense ratio of just 0.05% a year, or $5 for every $10,000 invested.
Since its inception, the stock market's average rate of return has been about 10% annually. Paying lower fees means you get to keep more of what you earn.
It’s not unusual to pay 10 times as much in fees to have your money invested in an actively managed fund, where an advisor is frequently trading the underlying securities in an effort to beat the market. The reality is, they often fail. If you care about optimizing your money and your time, index funds are it.
“It is not often in life that the easy thing to do is the smart thing to do,” economist Burton Malkiel writes about choosing index funds in the latest edition of his bestseller “A Random Walk Down Wall Street,” the tome that clued investors into the benefits of low-cost, passive investing some 50 years ago.
The hard part, Malkiel admits, is having the discipline to save small amounts and the confidence to keep doing it when the stock market appears to be in crisis. It’s a major test of our automatic human response to react when it feels like we’re in danger. Manage that and you can be well on your way to building wealth.
Consider Malkiel’s example of an investor who bought shares in Vanguard’s flagship equity index fund 45 years ago for $500 and invested $100 each month thereafter, through Black Monday, the dot-com bubble burst, the Great Recession, and the COVID-19 pandemic. In total they would have invested $53,200. Their portfolio by 2022 would be worth $1.5 million. That’s the magic of compound interest.
To be sure, the stock market has had -- and will continue to have -- some down months and years. It’s impossible for any investor, even someone who is paid to do it professionally, to avoid losing money in the short term. But the stock market as a whole tends to gain value over the long haul. Buying shares in an index fund gives you a cheap and rewarding seat on the ride.
