As 2023 nears a close, there's likely many tasks you should do before the year ends. However, none are as important as the one I'm about to discuss.
Whether you're a seasoned investor or just dipping your toes in the water, this advice is relevant for everyone. Above anything else, there's one investment you must make to give you confidence and be protected from a downturn in a specific market segment. What is this investment? Read on to find out.
Index funds have great benefits
This fabled investment is none other than a basic index fund ETF that tracks the S&P 500, like the Vanguard 500 Index Fund (VOO 1.00%) or the SPDR S&P 500 ETF (SPY 0.95%). Both are low-fee options that allow investors to purchase a broad exposure to the entire market index and not lose much performance to operating expenses.
With the Vanguard fund only charging a 0.03% expense ratio and the SPDR charging a 0.09% fee, each is a great option to avoid higher-cost mutual funds that can be a drain on long-term performance.
But why is buying an index fund a good idea? Well, there are many reasons.
First, it offers you broad market diversification. When you're just starting investing, buying these funds helps you avoid concentration into a specific market segment by giving you exposure to all fields. The same is important for well-seasoned investors, as they may have a particular interest in one sector (like tech or healthcare).
Second, while buying individual stocks with the potential to beat the market over the long term is a great and attainable goal, some investors may not be able to do this. By purchasing the market, you don't have to try to beat it because you've comfortably matched it. With a long-term return of around 10% annually for the market, it's already a fantastic investment in its own right.
Famed investor Warren Buffett thinks most investors would be better off buying an index fund and being done with it. In fact, Buffett instructed his estate to invest 10% in bonds and 90% in index funds after he passes away, which is a telltale sign of his belief in others' investing abilities.
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So, with one of the world's greatest investors recommending index funds, here are some strategies for deploying this investment alongside individual stock investing.
A balanced approach is a smart strategy
As mentioned above, buying an index fund when you begin investing is an excellent strategy. But as time passes and your investment knowledge grows, you'll likely be intrigued by individual stocks due to their potential to beat the market.
Many investors take a 50/50 approach, with 50% of their portfolio in an index fund, which guarantees market performance. The other half is then invested in individual stocks. While these two portfolio segments will have different returns throughout the years, as long as the individual investment portion outperforms the indexes over the long term, you'll be on the right track.
Another consideration is total portfolio allocation. Many people (like myself) have a 401(k) they cannot invest in individual stocks (although this is becoming less common). In this case, the 401(k) is likely much larger than your brokerage account, so index funds already make up more than half of your assets. This frees up brokerage-type accounts to invest in individual stocks, while the 401(k) provides the index fund backbone.
While these are just some thoughts, everyone is different. However, I strongly believe everyone should have some exposure to index funds, as they are one of the greatest tools in the market for providing life-changing growth, as long as one is patient with the market.
