If you invested in a very low cost index fund — where you don’t put the money in at one time, but average in over 10 years — you’ll do better than 90% of people who start investing at the same time.Warren Buffett – Berkshire Hathaway Annual Meeting (2004)
The data speaks for itself. The S&P 500 low cost index fund has been shown to outperform active investment. In a little under 10 years, a 10 thousand dollar investment in the S&P 500 index fund would have tripled by now.
While I have been a big advocate of value investing (Part 1, Part 2), a passive investment strategy can also be highly effective. A passive index fund investment strategy will guarantee success in the long run, and it should be the mainstay of your portfolio.
A long term investor (10+ years) who starts early will be highly rewarded. Because it is a long term strategy, any economic downturn will be negated by the eventual upswing in the business cycle.
When Warren Buffett dies, his wife is instructed to place 90% of their personal assets in index funds.
As of this writing, the best investment is in the S&P 500 because of the United States’ economic strength. The strength of the index is reflective of the strength of the US economy. In the future (2030 and on), if the US economy stagnates (example: Japan) this advice may no longer be true.
Here are the main benefits of investing in index funds as a passive strategy over value investing or real estate.
1. Maximize Your Time and Energy
When you invest passively, you are putting as minimal effort as possible into thinking about the stock market and economy. This means that you harness your energy and time into developing high income and personal skills, savings, and other ventures while still reaping great returns.
Value and active investors spend a lot of time reading. It is a side hustle in and of itself, and requires a lot of time investment. Passive investors have more time to focus on career growth, and maximizing savings or other ventures, which will maximize your wealth in the future.
If you can perform just as well as active investors by passively investing, this leaves time free for you to put your energy into other interests. By automating your investment strategy, you aren’t worried about the next crash, or what some CEO said in a tweet.
2. Low Overhead
Passively investing in low cost index funds means that you will incur less overhead on trades and management fees. The reason for this is because the stocks which are held in the index fund do not need to be managed.
This maximizes returns over time and provides lower barriers to entry for low income earners.
If you are just starting to get your finances in check, take this small step into financial success by opening an account with Vanguard. Buy the low cost index fund and automate your savings into it. It is an easy and effective way to get ahead now.
It is the most efficient effort to return investment that you can make.
The earlier your initiative, the greater wealth you will build for financial freedom.
3. Industry Diversification
Even though the S&P 500 has heavy weighting towards technology companies, an index fund provides diversification. An index strategy means that each share will represents control across many companies and industries. This is even more prevalent in a Total Stock Market Index than the S&P.
Once can argue that owning a lot of index funds means that you are weighted towards large cap stocks. This is a relatively aggressive and risky investment strategy.
To hedge against economic downturn it is recommended to also allocate a small part of your portfolio in other assets like REITs, Bonds, etc, which are all passive investments. This diversifies the type of asset which you own.
If you are 60 years old and looking to protect your wealth, the S&P 500 is a bad idea. If time is not on your side, you need to be looking for a low risk investment that can hold wealth. By the time you get a significant return, you will be dead.
However, if you are in your 20’s or 30’s its the best strategy because over the long run, it will maximize wealth.
The numbers and results speak for themselves.
You don’t need to be an expert, nor put in any effort. Know that this is a long-term strategy and while it may seem to stagnate at first, the power of compounding is the most powerful force in the financial world.
Comment below: How are you passively investing and what are your favorite assets?
I recommend reading Your Money or Your Life by Vicky Robin. It sheds a light into financial freedom that aligns with a passive investment strategy.