Theo Thimou, clarkhoward.com
When it comes to investing, Clark doesn’t get caught up trying to pick individual stocks of the latest and hottest “it” companies of the moment.
He’d rather not bet the farm on a couple of companies. That’s why he favors index funds.
And the gold medal goes to…index funds!
Index funds are a basket of stocks that mimics stock indices like the S&P 500 or the Dow Jones Industrial Average or any of a number of other popular ones.
When you buy an index fund, your money is split among the 500 companies in the S&P 500 or the 30 companies in the Dow, as just two possible examples. So you have a basket of little slices and dices of potentially hundreds or thousands of companies that you own a fractional share of.
“Instead of you buying an investment like an individual stock or a mutual fund where some brainiac tries to figure out what to buy, what to sell, how much of it to get… well, in an index fund it’s really simple; you just buy all the big companies in the country,” Clark says.
The nice thing about not having a fund that’s actively managed is that you don’t have to pay that “brainiac” an exorbitant salary in the form of a management fee. Management fees for index funds are minimal and therefore more of your money goes to work for you, not for somebody’s salary!
Here’s another nice thing to know: Index funds routinely outperform those actively managed funds that are handpicked by a brainiac.
In fact, index funds will beat managed funds a full 90% of the time, according to The Financial Times.
So you can sleep easy at night without having to worry if a stockpicker is right or wrong!
Remember Clark’s 3 Ds of investing
Clark has long said he’s dull as a person and as an investor. While we wouldn’t agree with him on the former, we can certainly agree on the latter.
You should be doing basic meat-and-potatoes investing. Clark’s portfolio favors index funds such as a total stock market index, a small cap index, an international index and an emerging market index, among other various tax-exempt bonds because of his income bracket.
No fancy stuff like futures, options, derivatives, etc!
By keeping it dull, he protects his capital and lets it grow for the long haul.
A broad portfolio with both domestic and international investments is best for long-term growth.
Diversification is the key. You have to spread your money out to lower your risk. A lot of people make the mistake of taking all their money and putting it into a stable fund or a guaranteed fund. Those options may sound like a sure thing, but they basically tread water.
Clark prefers that you have money in a total stock market index as a “go to” kind of investment. That’s where you own little pieces of thousands of companies. If one sector takes a hit — say, technology stocks, as they did during the “dot com” bust — your whole portfolio isn’t blown to smithereens because you’ve spread your money out across multiple industries.
Sure, diversifying is not as “sexy” as putting all your money into a single company and letting it ride. But investments should be about long-term security, not the dazzle factor.
Dollar cost averaging
By making regular contributions monthly in equal amounts, you are doing what’s called “dollar cost averaging.” That’s just a fancy way of saying you’re not trying to time the market.
In months that the stock market is going down in value, your money buys more shares. In months that the market is climbing, your money buys a smaller number of shares, but the shares you already own are worth more.
Dollar cost averaging is a way to pace your investing so that you’re buying shares when prices are low, high or in between.
Over time, putting money in this way reduces the possibility you will panic and either sell or stop investing; it keeps you steady as you go. And staying in the game makes you more money in the long run.
When the Dow Jones Industrial Average dropped to 6,547 in 2009, a lot of investors had their willpower tested. Those who didn’t sell out and kept putting in their $50 or $100 each pay period saw big gains on those shares when the Dow surged back. Today, the Dow is sitting at over 18,000!
No one knows what the markets will do in the future, but putting cash in every month in equal amounts really cuts your risk.