Unleashing Financial Growth: A Journey into Stocks and Index Funds

Posted by Financtitute on October 12, 2023 · 9 mins read

This is the fifth part of the Financial Independence Series:

  1. Understanding What It Means To Be Financially Independent
  2. Exploring the Spectrum of Retirement: From Mini Retirements to Barista FIRE
  3. Following the Money: A Beginner’s Guide to Budgeting
  4. Building Your Safety Net: The Importance of an Emergency Fund
  5. Unleashing Financial Growth: A Journey into Stocks and Index Funds
  6. Alright, So How Much Do I Need To Retire?

So, you’ve got your budget in check and your emergency fund is ready to go. Nice work! But let’s not stop there. It’s time to talk about giving your savings a job to do. There’s a world of opportunity to make that money work even harder for you. While there are many ways you can invest your money, today we are going to focus on the stock market, with index funds being the star of the show.

Why the Stock Market?

Before we dive into the complexities of the stock market, I think it will be helpful to have a grasp on the basics like stocks, ETFs, and mutual funds. If you are familiar with what these 3 terms mean, you can skip ahead to the next section.

Stocks signify ownership in a single company. Buying a stock means you own a part of that company. These can be traded freely during market hours, and there aren’t any management fees because you’re in full control of your stocks.

ETFs, or Exchange-Traded Funds, are traded on the stock market just like individual stocks. The difference is, an ETF represents a collection of stocks from various companies. It’s like a mixed bag offering diversity. There are some fees involved, given that these collections are managed.

Mutual funds are similar to ETFs in that they both represent a collection of stocks, but mutual funds are often more actively managed and have higher fees as a result. They are traded at the end of the trading day compared to stocks and ETFs which can be traded at any time when the market is open.

I hope this lays a solid groundwork for this post!

1. Accessibility and Diversity

One of the best parts about the stock market? It’s open to everyone. It doesn’t matter if you’re a millionaire or just starting to build your financial foundation - there’s a place for you. With a massive selection of companies, ETFs, or mutual funds to invest in, you have the flexibility to tailor a portfolio that aligns with your individual comfort level and risk appetite. With individual stocks there are thousands of companies to choose from. Some are household brands such as Apple, Amazon, or Exxon Mobile.

With ETFs and Mutual Funds, you can buy one share to contain a basket of different companies. If you can imagine a sector or industry, there is likely an ETF or mutual fund that will cover it. Lets say for example you want to invest in oil companies. Instead of cherry picking a handful of companies in oil industries, you could purchase VDE which is a Vanguard Energy ETF that has a mixture of oil exploration, production, refiners, and storage companies combined. In total there are 113 companies in this one ETF! Imagine trying to buy even half of those companies stocks. ETFs and Mutual funds really make it easier to diversify.

2. Liquidity and Flexibility

The stock market isn’t just about buying and holding(albeit that is a great strategy). While it may not be open 24/7 like your bank ATM machine, it is still open during business days. This means that you are able to buy/sell when the market is open and if needed, get access to your funds within a few days. This allows you to access your investments in the event of an emergency and you need more funds. This is why we have our emergency fund in a bank high yield savings account but we have stocks that we can sell in case we have a larger event happening.

3. Historical Returns and Growth Potential

Despite its ups and downs, historically, the stock market has grown over the long term. That means by hanging in there, you’re giving your money a chance to grow, helping you outpace inflation and increase your purchasing power. If you have a plan to not need the money within 5 years, the stock market has generally been a good bet source.

Index Funds: The Modern Maven of Investment

1. Diversification at its Best

Index funds, by design, mirror the performance of the entire market or specific sectors. This means that when you invest in an index fund, you’re essentially spreading your investment across all the assets within that index. This automatic diversification curtails the risk tied to the downfall of any single asset, offering a buffer against drastic declines.

When you pick an index fund, you’re basically buying a little piece of every company listed in that index. It’s like a sampler platter of investments, reducing the risk of a loss if a single company doesn’t perform well. I personally like the S&P 500 index which contains 500 of the largest US companies in an index or a total market index which contain almost 4000 small, medium, and large companies in a single index. What I love about these broad indexes is that I don’t need to manage or do research. The historical returns we talked about earlier was for the stock market, not individual stocks or sectors. Buying an index fund is just easy and the returns are better than most people (even professionals!) can do.

2. Cost-Effective and Efficient

Picking individual stocks usually means significant research, expertise, and time. Not to mention, actively managed funds often come with hefty fees. Index funds, being passively managed, bypass these hurdles. They typically sport lower expense ratios, ensuring that a larger chunk of your money stays with you and continues to compound. An actively managed mutual fund on average has a .6% expense ratio, meaning that 60 cents of every $100 or $600 of every $100,000 per year goes to the companies managing these funds. On the otherhand, index funds are closer to .1% or 10 cents of every $100. That is a huge difference when it comes to fees.

3. The Folly of Timing the Market

Time in the Market Beats Timing the Market

- Ken Fisher

A common pitfall many investors succumb to is trying to time the market, an endeavor even seasoned professionals struggle with. Index funds sidestep this challenge. With index funds, you’re not trying to beat the market or make predictions. They offer a straightforward approach to investing, reflecting the performance of the market index they track. In fact, its so hard to beat the market that the vast majority of actively managed funds do not beat the market over a 10+ year period.

What Are We Doing?

We are big fans of index fund ETFs. However, we do like a bit of additional exposure to small/medium cap companies as they generally have higher growth but also higher volatility which we are comfortable with at this time. Because of this, we have included those ETFs to gain more exposure. We have the following index funds as an example with their respective ratios. These are set to invest automatically every pay period so that we don’t have to think about investing.

  • 50% - Total Stock Market Index - VTI
  • 20% - Mid Cap Index - VO
  • 20% - Small Cap Index - VB
  • 10% - International Index - VEU

Having a budget and an emergency fund is a strong start, but investing is where the journey to financial growth really kicks off. The stock market offers a space to grow your savings, and index funds stand out as a balanced, cost-effective option. As you venture into investing, remember it’s all about the long game - patience and persistence can compound and snowball into something amazing.