If you follow financial figures on social media, chances are you’re inundated with new ideas every day. Whether it’s buying stocks, “HODLing” cryptocurrency, or trading options, it seems there’s always a new way to get rich faster.
While some people 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 can be a simple thing to do.
“The smartest people in finance do one thing: They buy a basket of stocks (ETFs, MFs) at low fees and don’t look back,” marketing professor, podcaster, author and all-around financial influencer Scott Galloway. wrote in a recent post on Twitter.
Eric Balchunas, a senior exchange-traded fund analyst at Bloomberg, echoed a similar sentiment. “If your goal is to hook it up with the billionaire Wall St ppl/apparatus, then just buy and hold a cheap index fund. That’s the only way to do it. And you’ll get rich in the process, doubly so,” he wrote. on Twitter.
Instead of getting bogged down in the daily market turmoil, long-term investors are better off buying diversified investments on the cheap and hanging on to them for the long term, financial experts say. That is why.
Why diversification helps you as an investor
Buying a broad basket of investments ensures that you don’t bet too big on any one in particular.
“It all comes back to the whole idea of not putting your eggs in one basket,” says Amy Arnott, a portfolio strategist at Morningstar. “By diversifying, it can help you avoid overexposure to a certain 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 broad portion of the market. Funds labeled as “total stock” funds typically 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 built on the bullish trajectory of the 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 to 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 it is better to buy diversified funds than individual investments, then the question arises, which fund to choose? All things being equal, the cheapest.
As Vanguard founder Jack Bogle put it succinctly: “You get what you don’t pay for.”
That’s because every dollar you pay 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 can grow at a compound rate alongside your investments. .
Consider two funds. You invest $10,000 in each, hold for 40 years, and each earns an 8% annual return.
A fund charges annual expenses of 0.50%. After 40 years, your $10,000 investment in such a fund would be worth about $178,000 with you paying $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 only $215,000. Your total charges over four decades: $832.
Leave your wallet alone
Once you’ve built a low-cost, broadly diversified portfolio, Galloway and other financial professionals suggest you’d be wise to never look at it again.
While it’s smart to check your portfolio from time to time, especially to make sure your allocations are in line with your risk tolerance, the more you interfere with your portfolio’s day-to-day affairs, the more likely you are to make a decision that hurts your investments.
Decades of academic studies show that almost all day traders—those who try to make profits by 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 affects their financial decision-making.
If you’re skeptical, think about how you would invest during a roaring bull market versus when stock prices are falling. Ideally, investors will tend to buy more when prices are low. But that’s usually not the case, says Kelly LaVigne, vice president of consumer insights at Allianz Life.
“When the market is doing well, people are throwing their money into it. When it’s doing poorly, they’re keeping their money out,” he told CNBC Make It. “That’s doing the exact opposite of what you’re supposed to do.”
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