Index Funds: A Simple Way to Invest in the Market
If you are suddenly given a sudden windfall of cash, receive an inheritance, or even win the lottery, what should you do with your winnings? As a basic investor, how do you get started? Let's assume you have $100,000 to invest. This is just a sample number chosen to illustrate the concept. It could be a larger or smaller amount. The idea is similar.
Assume you also have created an account at a trading company such as eTrade. Assume you have analyzed your own financial situation and have a good snapshot of your personal financial health. What do you do next?
How to Start Investing With Index Funds
The most simple strategy for investing in the stock market is to buy index funds. These are funds that are an average of a large number of individual stocks. The idea is to spread the risk across multiple investments without having to individually invest in many companies.
There are a few choices of index funds. My personal favorite is SPY. This fund tracks the S&P index. It is diversified and can be bought and sold at any time during the day. Assume you have $100,000 sitting in your cash account at eTrade, and consider the following process.
- Determine the amount you may need over the next 24 months. For example, between your retirement pension and your social security payment, what is the extra amount you may need to live at your current level? Let's say it is $40,000 (20K per year). This is your cash reserve.
- The 60,000 left should be invested fully in the index fund (SPY). The current value as of today is $227.21.
- Use dollar-cost averaging to buy into the fund over the next five or six weeks. The reason is simple. You want to minimize your cost. No one has a crystal ball. You can't know what is a low price and what is a high price. The next best thing is to dollar cost average. That means to buy a portion of the whole on a fixed day for the next five weeks. In this example, you'd want to buy approximately $10,000 worth of SPY rounded to the nearest 10 shares. That's 50 shares every Monday morning. Repeat the order for the next five weeks until your 60,000 is fully invested.
- That's it! Now just sit back and wait.
What About Fees?
Let's see fees are It $3 per trade. 3*6=18. 18/60,000=0.03%. That is insignificant. The average return of SPY for the past 10 years has been 6.87%.
if you have $100,000 at the beginning of year and invest $60,000 in SPY in this manner, you will end up with $104,100 at the end of the year. This is a net return of 4.1%.
The simple strategy is this: Keep a portion of your savings in cash as a reserve. Invest in an index fund for its diversity and to mitigate risk. Check periodically and monitor it yearly. Don't panic-sell when the market undergoes periodic corrections. Be patient.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2017 Jack Lee