Use Index Funds To Make Investing Simple

By Floyd Saunders, Founder of Really Simple Investing and the author of Five Paths To Wealth, Family Financial Freedom and Figuring Out Wall Street.

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Investing can be really simple. You don’t need to learn about technical or fundamental analysis or develop trading strategies.

The fact is that most professional traders lose money and most of the professional managing mutual funds don’t manage to consistently beat the benchmark indexes they compare themselves too.

Most of us don’t really want to be investors anyway, we live busy lives and worrying about which stocks bonds, or mutual funds to own is just too much work. The fact is most of us would just like to have a really simple approach to investing. Something that you can stick with over time, and have the confidence that you have your investment needs covered.

Use Index Funds To Make Investing Simple

Here is the one approach that makes investing really simple. Buy everything. Yep, it’s that simple. And you can do it with very little money by investing in just three index funds that allows you to cover the entire U.S. stock market, most of the U.S. bond market and get broad exposure to international stocks. And you can use index funds to make investing simple.

Pick “Exchange Traded Funds” or ETFs, over mutual funds as ETFs typically are less expensive and easy to purchase. ETFs are funds that trade on an exchange like a stock. They are an easy to use, low cost and tax efficient way to invest money and are widely available on most investment platforms.

Why index funds? The numbers shows that over time index funds will beat actively traded or managed funds. Roughly two-thirds of actively managed funds fail to beat simple index funds. This is simply because ETFs costs are typically just 1/3 the costs of an actively managed fund.

Rather than trying to beat a benchmark, index funds dare to be average. They aim match a market barometer, such as Standard & Poor's 500-stock index or the Wilshire 5000 or the Russell 2000. Consequently, they don't require any monitoring. It doesn't matter much whether the manager leaves or stays put. Index funds have such an easy job that they tend to achieve their goals no matter who's in charge.

The best index ETF funds -- those provided, most notably, by Vanguard and Fidelity –have the lowest fees and expenses. Expenses range from less than 0.1% of assets annually to a still-modest 0.35% annually. By contrast, actively managed funds typically charge more than 1% for annual expenses (that doesn't include sales commissions, which many funds charge)

Suggested Three index-fund portfolio

Want to invest with a minimum of fuss and a maximum of simplicity?

All it requires are three index funds. You can turn to either Vanguard (www.vanguard.com 800-635-1511) or Fidelity (www.fidelity.com; 800-544-6666). I prefer Vanguard because they maintain rock-bottom pricing on their fees and you want every nickel invested. Blackrock iShares, Charles Schwab and State Street also have three fund portfolios you can use.

1. Put 75-80% of your stock money in a Total Stock Market ETF

For example the Vanguard Total Stock ETF (VTI) covers the entire U.S. stock market.

With this ETF you get shares of large, midsize and small companies so your will see a modest but solid return over time.

2. Invest 10% in the international stock market

Vanguard Total International Stock ETF (VXUS). It gives you the rest of the world with broad exposure across developed and emerging non-U.S. equity markets.

3. Then invest your last 10% in a total bond fund

The Vanguard Total Bond Market ETF ((BND) gets you most of the U.S. bond market and provides the balance you want. Generally bonds will underperform stocks, but the income stream in the form of interest payments offsets any of those times when stocks takes a dip.

The only issue you might have with Vanguard is they require a minimum investment of $3,000 to start an account. You can get the same type of indexes using iShares and in most cases you need to only buy a few shares to start.

To buy the U.S. stocks market, put 75 to 80% in iShares Core S&P Total U.S. Stock Market ETF (ITOT). For your international exposure, put 10% in iShares Core MSCI Total International Stock ETF (IXUS). Finish with the reminder in iShares Core Total USD Bond Market ETF (IUSB).

How much should you put into bonds? If you're investing for retirement, keep 80% or more in stocks until you're within five years of retirement. Then start selling your stocks until you're 40% in bonds by the time you retire. You will need the 60% exposure to stocks to continue to grow your investment during retirement.

If you're investing for your child's education, start with 90% or more in stocks and begin scaling back when he or she gets within five years of college. Then gradually sell your stock funds first and then your bond funds until you're entirely in cash by the time your child is midway through college.

Does 80% or more in stocks seem too risky? You can pick different allocations if your fell this approach is too risky, but the math is simple: Stocks have always been the long-term winners, returning more than 10% a year on average since 1926. Bonds have produced about half that. Inflation, over the same time has averaged 3%. Realize that when inflation is deducted from your returns, your real returns are less, but still better than any savings account or certificate of deposit.

Put less in stocks if you think you're likely to bail when the market tanks. You'll do fine with 70% or even 60% in stock funds. But if you have the stomach for it, put 80% or more in stocks.

That's it. That's the whole plan. Investing really can be simple. But you have to stick with the plan, even when it doesn't seem to be working. Based on past results, you'll beat at least two-thirds of other fund investors.

Floyd Saunders is the author of Five Paths to Wealth, Family Financial Freedom and Figuring Out Wall Street. You can learn more about him at his author web site.

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Book cover design by Ashley Dameron. .