The Truth Why Most Investors Are Best Served With Index Funds

Modest Money  |


There are many options for investors when it comes to investing. There are also many theories as to how to best position yourself to make the most money investing. While there are arguments to support all of the various investment strategies and options, for the overwhelming majority of investors, you are best served by simply investing in index funds.

While this strategy isn’t sexy or glamorous, the truth is that it works. And seeing as how most investors earn much less than the market in a given year, a simple investment plan that invests in index funds and returns close to what the market earns is a winner.

Let’s look at some of the reasons why most investors are best served with this form of investing.

3 Reasons Why You Aren’t Going To Beat The Market

#1. You’re Too Emotional

The biggest flaw of most investors is they allow their emotions to cloud their judgment. Behavioral financial covers many of the issues related to emotional investing. But here is a quick run-down of the bigger ones.

  • Anchoring: this is when you buy a beaten down stock thinking it is undervalued when in reality it was overvalued. But you see the higher price and still think the stock will get back to this price level.
  • Gambler’s Fallacy: this is when you think that the stock market is going to rise after falling for 3 straight days. There is no reason for the market to rise just because it had been negative for the past couple of sessions.
  • Herd Behavior: this is when you buy certain stocks because everyone else is. Or in the most recent case, you buy Bitcoin because everyone else is.

When you allow your emotions to make decisions for you, you are bound to make a poor choice. Just take a few minutes and look back on your life. How many times did you make a rash emotional judgment and the outcome ended up being good?

Chances are few to none. In order to be successful as an investor, you need to stay calm and think through every action you make before you do it. This is why financial advisors create an investment plan for you.

By having a plan, you have a document of what you are doing and why. When you get the itch to buy or sell, you simply refer back to your plan and make a smart, emotionless decision.

#2. You Can’t Time The Market

As smart as we think we are, no one is smarter than the stock market. This means you cannot time the market. You never know when the market is going to have a major move to the upside or the downside.

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And missing these days has a meaningful effect on your wealth. For example, if you missed out on the 10 best days, you cost yourself a staggering $30,000!

When are these 10 best days going to happen? You’re guess is as good as mine. The reality is you are better off keeping your eye on the long-term and keeping your money invested at all times. This means in both a rising and a falling market.

It sounds counter-intuitive to keep your money invested in a down market but you don’t know where the bottom will be. And if you sell out at the bottom, you are guaranteeing yourself of missing out on a good portion of climb back up.

#3. No One Beats The Market

After reading the points above, you might think your best option then is to hire an investment professional to earn you a higher return. The sad news is that even the experts can’t beat the market on a consistent basis.

Sure they might get lucky and have a run for a year or two, but that is it. After this, they regress back to the mean.

In recent history, the best investment professional has been Bill Gross. He beat the market for 15 straight years. But even he admits it was more luck than anything else. He has said that if the year ended on a different day, his streak would have ended much sooner.

The point is, no one, not even the professionals can beat the market over and over. And no one knows when they will beat the market or for how many years. In other words, to pick the investment professional who is going to beat the market this year, you are going to have to get really lucky.

Then you are going to have to get really lucky again to sell before their performance suffers. Then you have to get lucky again to pick another winner.

The bottom line is you are better off investing in index funds and taking what the market give you.

The Benefits of Index Funds

So what is the benefit of index funds? The simple answer is that they will give you a predictable return every year. You know that whatever the market returns, that is what you are going to earn. No more spending money on an investment professional hoping they can earn you a higher return.

If you invest on your own, no more spending countless hours researching, buying and selling stocks. You simplify the entire investing process and have more free time and earn a decent return.

Final Thoughts

At the end of the day, most investors are best served investing in index funds. Don’t make investing overly complicated. The simpler you keep it, the more likely you will stick with it for the long run, which is exactly what you need to do in order to be successful and grow your wealth.

Don’t get greedy or scared when it comes to investing. More often than not, you will lose money when you let your emotions enter the picture. Accept that the market is efficient and take what it gives you. Your future self will be happy you did.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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