Whether it is funding a college education or living your retirement years free from financial worry, it all comes down to the decisions you make in your life to achieve those financial goals.
One decision that is easy to make, is to admit to yourself that any effort to select the top stocks and industries to lead us out of this recession is a waste of your time and money. That doesn’t mean that you shouldn’t own any common stocks, because maybe you should.
First, you need to develop your own financial plan. This is the document that drives your asset allocation decision, determined by your need and ability to take risk. Once you have chosen an appropriate allocation to common stocks, you then need to decide how best to invest in this asset class.
With thousands of stocks and actively managed mutual funds to choose from, and countless market pundits predicting which ones are best for you, the decision can be overwhelming. Fortunately, it doesn’t have to be. For Coffeehouse Investors, it is as simple as owning a couple of low-cost index funds and getting on with your life, and attending to the important decisions that DO matter.
Index funds are mutual funds as well, but are unique in design. Instead of having a professional stock-picker in charge of trying to pick the top performing stocks, these investments own ALL the companies that make up a particular index; the good, the bad, and everything else in between.
For many investors, the concept of investing in index funds is hard to accept. Why settle for the “market average” when you can beat the “average” by picking the top-performing stocks?
In theory, that argument has merit. In reality, it falls flat, because it is the wrong question to ask yourself.
Even though exhaustive research has shown that the vast majority of actively managed funds underperform the market, it is “possible” to beat the stock market average, as stock pickers like Peter Lynch have proven. A more relevant question to ask is, “What is the price I pay if I try to beat the market, and fail?”
For investments that are meant to be “long-term” in nature, studies have shown that owners of individual stocks and actively managed mutual funds, even investors who profess to “buy and hold,” end up trading these investments at an alarmingly high rate in search of higher performance. The result is a portfolio with returns significantly below benchmark averages. It doesn’t make much sense to take all the risk inherent in owning common stocks, and consistently underperform a benchmark, especially when you can own the benchmark!
Beyond maximizing your investment returns in common stocks, a greater benefit of investing in low-cost index funds is that it allows you to focus on essential wealth management decisions, like how much you spend or save, to reach your financial goals. For investors who are in control of their financial destinies, these are the decisions that matter most of all.