Have you noticed how people’s greatest strengths can also be their Achilles heel? Creative thinkers tend to be impatient. A business owner’s competitive drive can turn against them at home. Skills we learn in one part of our life may or may not translate well to other parts.
I was reminded of this when a brilliant friend of mine was about to realize a tidy sum from her most recent business venture. As we talked over how she might invest the proceeds, she asked me an excellent question: Nancy, why would I buy an index fund?
What she was really asking was this: “As an entrepreneur, I’ve come out ahead by working hard, spotting trends and seizing them. Why would I settle for such a boring strategy as an investor?”
In this “No Dumb Questions” segment, let’s talk about what an index fund is, and why “boring” investing is often a successful investor’s smartest answer.
First, let’s define what an index fund is. An index measures the performance of a market by tracking a sampling from it. For example, the S&P/TSX Composite index measures the performance of the Canadian equity market by tracking about 240 Canadian and U.S. stocks. As of the end of July 2016, the index was reporting 10-year annualized total returns of just over 5 percent.
As the name implies, an index fund invests in the same stocks its namesake index is tracking. Invest in that fund, and you’ll earn the returns the index is reporting, after expenses. Because index funds are pretty easy to manage – no fancy-pants analysts required – their expense ratios are usually very low.
In short, an index fund lets you earn almost all of the returns a market has to deliver, without having to be incredibly clever or incredibly lucky. Plus, they’re typically bargain-basement priced.
Now, contrast that to how most investors approach the market, including my entrepreneur friend. It’s no wonder she thinks that the best way to make money in the market is by working hard, venturing into high-priced products, and hoping to win more often than she loses.
In business, predicting future trends and outsmarting the competition are great ways to get ahead. But investing calls for a completely different mindset. Here, you want to avoid costly attempts to outsmart a highly efficient “investment machine,” which is essentially what our capital markets are. Instead, wise investors position themselves to earn the returns that this machine has churned out over time with relative ease. For investors, planning, patience and cost control are the names of the game.
Bottom line, which would you rather do: Have exciting adventures in the markets? Or achieve the personal financial goals you’ve set for you and your family? If you ask me, since index and similarly structured funds are best suited to help you achieve those personal goals, they’re not so boring after all.
I’ll cover more insights to help you be a smart investor. Or send me financial questions that are troubling you, and we’ll keep the conversation going.
