How To Start Investing

New to the world of investing? Ruth shares her journey from newbie to seasoned investor, giving us a quick 101-rundown on her favorite investment approach, the humble index fund. Find out why Warren Buffett recommends index funds as the best way for everyday investors to grow their money, as well as some quick ways to start!

Investing in shares is entering the mainstream. There’s been a surge globally in the number of platforms and providers that make investing easy. Hundreds of people are signing up every day to grow their wealth.

To that, I say, “Hoorah!” But I also caution it with a “Hold up, just wait a minute or two, please!”

I am heartily in favor of people investing in the share market for the first time, but I don’t want it to be the only time, and I want to give them the confidence to become long-term educated investors. To do that, having just a little bit of knowledge upfront will save you from lost returns in the long run.

A short history of index investing

Today, I have a short, sharp history lesson on index investing, and I promise you will come away from it more educated than when you began.

When I realized I didn’t have to learn how to pick individual company shares to become an investor, it felt like the clouds had parted, and the sun finally came out. I have the late John C. Bogle to thank for that.

I first heard of him when I was trying to learn how to start investing to grow my money, something it certainly was not doing at the bank. My only options appeared to be ‘stock picking,’ but gut instinct told me that picking individual stocks was fraught with danger for a complete novice like me.

So, I started to research my options, and that was when I stumbled across Mr Bogle for the first time. He had read an article by economist Paul Samuelson who had worked out that professional investors could not perform any better than the average of the whole stock market.

John Bogle took the time to test Mr Samuelson’s theory by looking back over 35 years of individual company data and finding the average, only to find that the economist was right! So he founded the company Vanguard, putting the theory into practice, and created the first index fund in 1976.

Index funds demystified

This fund contained the biggest 500 companies in the US stock market. All of them were in this fund in proportion to their size. So when you are listening to the news, if the S&P500 rises on that particular day, your index fund rises; if it falls, your fund falls. An index fund follows the direction of the market.

Professional investors thought it was a dumb idea. An index fund follows the average, and who wants to be just average? These guys thought they always had the skills to pick the top companies (despite the research to the contrary), and they thrived on the excitement of it. They also liked to charge investors handsomely for their advice. Index funds were dirt cheap in comparison because there was no stock-picking involved. Few people were required to manage the fund, meaning fewer people to pay.

John Bogle wanted share investing to be boring yet effective, and he wanted people to invest, not speculate on stocks. And he succeeded.

As an investor, you don’t do anything. Instead, the companies in the fund do all the work for you. He wanted people just like you and me to have a shot at creating wealth using the stock market in a simple way. His fund thinks long-term – it’s low cost, extremely diversified, with no need to buy and sell and continuously trade.

Index funds vs. hedge funds

Through my research, something called The Bet was regularly mentioned. After a bit of googling, I discovered Warren Buffett. He proposed a bet where he invests USD$320,000 in an index fund, and a hedge fund manager invests the same by actively picking stocks. The winner would get $1,000,000. The bet began on January 1, 2008.

Buffett said he was doing this “to publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be.”

Year one was terrible for the index fund, and the hedge funds were way up. But as 10 years ticked by, the index fund repeatedly beat the hedge fund. The hedge funds for the remaining five years trailed the index.

The bet ended on December 31, 2017, with the results being that the hedge funds gained only 2.9% a year after fees (which were large) while the index fund gained an average of 8.5% a year. Buffett won the bet.

This bet beautifully showed me how an index fund works if you just give it time. It also showed me that it’s better to just index for those who don’t have a room of fund managers working for them. Heck, for those who do have a room of fund managers working for them, it is still better to just index! When I learned that I didn’t have to try to learn how to pick a fund manager or stocks, my relief was immense.

Eight essential rules for investors

These are John Bogle’s eight essential rules for investors:

  1. Select low-cost funds
  2. Consider the added costs of advice carefully
  3. Do not overrate past fund performance
  4. Use past performance to determine consistency and risk
  5. Beware of stars (as in, star mutual fund managers)
  6. Beware of asset size
  7. Don’t own too many funds
  8. Buy your fund portfolio – and hold it

The final piece of my index fund education came in the form of a book called The Simple Path to Wealth by J. L. Collins. Again, he explained how index funds work as opposed to buying individual stocks. He, too, proposed buying a broad-based index fund consistently over a long period of time. And never sell!

After learning all this, I just had to know where I could find this simple, broad, low-fee index fund in New Zealand. Thankfully, index funds were established here, and I quickly tracked them down.

Start investing with as little as $5

Today, I buy a set dollar amount every month of just two index funds, a US Top 500 fund and an NZ Top 50 fund. I am sticking firmly to John Bogle’s advice to buy your fund portfolio and hold it, and I rarely take a look because there is no need to. But when I do, just like in The Bet, over time, my investments are performing well.

There are many index fund providers in New Zealand that you can choose from. Each is low cost, each tracks an index, and the new investor just has to stick to the eight rules above to make their choice.

Options in New Zealand include:

So, thanks to John C. Bogle for teaching a masterclass on investing for beginners, driving down the cost of investing and making it simple, and teaching me to diversify and buy and hold.

You have taught me that ‘average’ can be awesome and that I don’t have to know everything to make a start today! My regret being I didn’t find you sooner, but I know that the best time to start investing is yesterday, and the second-best time is today.

Ruth blogs at all about how she and her family handle money. What’s the secret? Spend less than you earn, invest the difference, avoid debt and budget each dollar that flows through your hands. She firmly believes that if you can just get the basics right, life becomes easier from there on in.

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