If you follow financial figures on social media, chances are you’re getting inundated with new ideas every day. Whether it’s buying stocks, “HODLing” cryptocurrency or trading options, there’s always seems a new way to get richer faster.
While some people do manage to get rich quick through trading, for most, building wealth is a long-term game. And when your goal is decades away, the best advice tends to be boring. In fact, it may boil down to doing one simple thing.
“The smartest people in finance do one thing: they buy a basket of stocks (ETFs, MFs) that’s low fees, and they don’t look at it again,” marketing professor, podcaster, author and all-around financial influencer Scott Galloway wrote in a recent tweet.
Eric Balchunas, a senior exchange-traded fund analyst at Bloomberg, expressed a similar sentiment. “If your goal is to stick it to the billionaire Wall St ppl/apparatus then just buy and hold a cheap index fund. That’s only way to do it. And you’ll get wealthy in process, a two-fer,” he wrote on Twitter.
Rather than toileting away in the market’s daily nitty gritty, long-term investors are better off buying diversified investments on the cheap and hanging onto them over the long term, financial experts say. Here’s why.
Why diversification helps you as an investor
Buying a broad basket of investments ensures that you’re not taking too big a bet on any one in particular.
“It all goes back to the whole idea of not putting your eggs in one basket,” says Amy Arnott, a portfolio strategist at Morningstar. “By diversifying, that can help you avoid being overexposed to any one particular area of the market when it’s out of favor.”
This is where mutual funds and exchange-traded funds come in. These baskets of stocks are designed to give you exposure to a wide swath of the market. Funds branded as “total stock” funds generally hold a representative sample of the entire US stock market, while “total bond” funds do the same for bonds.
Holding large mixes of stocks and bonds has historically been a good play — one that has relied on the upward trajectory of broad US markets.
A portfolio of 80% stocks and 20% bonds, with each component represented by broad market indexes, earned an annual return of 9.6% from 1926 through 2019, according to calculations by Vanguard.
Low-fee mutual funds and ETFs: ‘You get what you don’t pay for’
If you agree with the experts that you’re better off buying diversified funds than individual investments, the question then becomes, which fund do you choose? All things being equal, the cheapest one.
Put succinctly by Vanguard founder Jack Bogle: “You get what you don’t pay for.”
That’s because every dollar that you pay to a mutual fund or ETF company in the form of an expense ratio — the annual management fee you pay to own a fund — is a dollar that could be growing at a compounding rate alongside your investments.
Consider two funds. You invest $10,000 into each, hold for 40 years, and each earns an 8% annualized return.
One fund charges annual expenses of 0.50%. After 40 years, your $10,000 investment in such a fund would be worth nearly $178,000 with you having paid $12.145 in fees over that period.
The other fund charges an expense ratio of 0.03% — the going rate for many ETFs that track the performance of broad stock market indexes. After 40 years, your investment in this fund is worth just shy of $215,000. Your total fees over four decades: $832.
Leave your portfolio alone
Once you’ve established a low-cost, broadly diversified portfolio, Galloway and other financial pros suggest that you’d be wise to never look at it again.
While it’s smart to check in on your portfolio occasionally, especially to make sure your allocations are in line with your tolerance for risk, the more you meddle in the day-to-day goings on of your portfolio, the likelier you are to make a decision that hurts your investments.
Decades of academic studies show that nearly all day-traders — those who attempt to earn profits from buying and selling investments on a daily basis — lose money over long periods.
Plus, nearly all investors — 98% in a recent Morningstar study — exhibit at least one cognitive bias that negatively impacts their financial decision-making.
If you’re skeptical, think of how you would invest during a roaring bull market versus times when stock prices are falling. Ideally, investors would tend to buy more when prices are low. But that’s not usually the case, says Kelly LaVigne, vice president of consumer insights at Allianz Life.
“When the market is doing well, people are throwing their money at it. When it’s doing poorly, they’re keeping their money out,” he told CNBC Make It. “It’s doing the exact opposite of what you’re supposed to be doing.”
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