Index Funds

Is a safe low yield account going to make you rich? If you’re working 40 hours a week and saving in a checking account at .01% it will get eaten by inflation. Saving at .01% causes its value to evaporate slowly. It loses value with time, and at some point, it will be worthless. We need to keep up with inflation. We need a way to grow money to beat inflation. What about stocks?

Stocks increase risk. No one wants to lose money but to compete with inflation stocks will need to play a part. To become rich we need to manage risk. The truth is that no one knows if the stock market will go up, down or sideways. If stocks go down it’s like getting a discount at the store. I know everyone would like to get 5%, 10% or 20% off at the store. “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”-Warren Buffett. We need to think of applying this same principle to stocks. If they go up then we are making money. If they go down then there are some bargains to be had. Here is how we win no matter what happens with the stock market.

Historically, stocks return 10% annually if you invest your money for ten years. Bonds are 2.69% and savings accounts are 2.20%. So, if we want to collect more dollars we need to invest in stocks. How can we compete with the experts on the stock exchange often shown in the news with their hands on their faces for extra drama? If these guys are the finance experts how can we beat them?

Warren Buffett bet a million dollars that over a period of ten years an index fund would outperform a managed hedge fund. An index fund is a type of mutual fund that tracks a market index like the S&P 500. With an index fund you spread your money across many companies, buying just one stock. An index fund allows for diversification and lower overall fees. Buffett won that bet! The index fund yielded 7.7% and the hedge fund was up just 2.2%, over a period of ten years. The hedge fund had high fees and the index fund had low fees; thus over a ten year period those fees add up and reduce earnings. Warren Buffett is one of the most significant investors of all time, if we can learn to model his behavior we can truly learn to think like the rich.

The main point here is we need to invest in vehicles that beat inflation. Beginning investors or people that do not have the time and money to pick individual stocks can learn from Buffett’s bet. Invest in index funds, not in individual stocks, or you may be taking on too much risk. We need to reduce risk and improve returns.

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