Sometimes it’s hard to do what’s important and what matters as it pertains to investing. It’s not the return on your investments that ultimately matter, but its if you’re able to stay the course in order to get that long term compounding interest that will double and even quadruple your investments every 10 years or so. You see, when it pertains to investing, the proverbial chicken does actually come before the egg; and if you’re after that golden egg then staying the course is how to get your hands on that golden egg laying chicken.
That’s why it may be easier to invest in index funds. Index funds typically have less volatility than individual stocks. So over time if you look at your returns you won’t see large swings of positive or negative returns over the years. You will have average losses and gains compared to individual stocks. It’s hard to see how close you are to the shore when you’re on a boat with ten foot waves crashing on top of you. This can be the feeling when you’re investing in individual stocks. With individual stocks You may have 5 or 10 year periods of great returns or terrible losses verses average returns and average losses with a total market index fund. You have to know your risk tolerance and ability to stick to your strategy with investing in individual stocks and index funds, but the added volatility of Individual stocks can cause doubts and may call for frequent analysis of companies to determine the effectiveness of your stock picking strategy, especially when individual companies can go bankrupt. It’s harder to be a buy and hold investor with individual stocks because of this. Especially when it takes concentrated risk to to build wealth.
For example, you may have friends that boast of how they made a 60% gain by buying stock X when it IPOed and then selling it six months later. But Chances are they invested a couple grand and let’s just say $5000. A 60% return would be a gain of $2500. If you had 100 grand and Invested it in an index fund that same year and just averaged a 10 percent return you would have made a $10,000 return. Was your friend confident enough to risk a 100 grand on that IPO? Probably not. So safely putting more money in a lower risk investment that allowed you to sleep well at night and earn more investment dollars than speculatively investing was the best approach for greater returns in the case of capital. Let’s face it, you have to concentrate a large amount of capital in a diversified portfolio to build wealth overtime, while avoiding over diversification and speculation.
Concentrated risk and time in the market are two of the greatest tools used to build wealth in the stock market and it should be the two things that are the most sought after. Get 1-3 low cost diversified index fund(s) or its equivalent mutual fund and hold them for 15-30 years. If you’re into individual stocks then get a well diversified portfolio of 15-30 stocks and hold onto them for 15-30 years. Re-balance annually and sometimes biannually or quarterly during major market crashes that pushes your portfolio 10-20% away from your asset allocation. What we shouldn’t do is have a complicated asset allocation with 100 different factors and mutual funds with portfolio tilting in 10 different directions. This waters down the power of the portfolio and leads to over diversification. There is something to say about being decisive and setting up an investment plan and sticking to it; and after that, all you have to do is focus on the hard part. Which is to sit back and do absolutely nothing. Just hit re-balance from time to time. I wish I was being sarcastic about the latter, but I’m not. It actually is hard to stick to your guns, especially when there is panic in the markets and it seems like everyone is getting out. Doing nothing is hard.
It’s better to have a few stocks or a total stock market index fund and buy them over and over again either through reinvesting of dividends or automatic recurring investments of dollars or both. Passive investing should be viewed similarly to investing in a 15-30 year CD with no early withdrawal options. This will allow for both concentration of capital and time effect of compounding interest to do its magic and build wealth over time.