Index Investing: The Carefree Way to Own It All
In the last year, a single share of Tesla stock (ticker "TSLA") has fluctuated from $70.10 to $900.40, and has been in a bit of a free-fall this month (February 2021) along with most technology stocks, closing at $682.22. I remember excitedly texting my boyfriend a few days ago when I saw that Tesla had fallen to $636 thinking this was my chance to buy while it was at a relative low. In a mad rush, I logged in to my brokerage account, quickly pulled up TSLA to place a buy order, and just as I was double-checking the terms of trade before hitting the confirmation button to place the order I got distracted by a phone call. By the time I was off the phone, the price had shot up to about $675...and that's the price I bought at (still, not bad!).
If I could only recommend a single personal finance book, it would be The Simple Path to Wealth by JL Collins. It is short, easy to read, experience- and research-based, and he explains the importance of having "FU money" and the beneficial "self-cleansing" nature of index funds.
Over the course of the next few days, the overall stock market continued its freefall, and some of the trades I had sloppily rushed to place ended the week with an (unrealized) loss. I realized that at this phase in my life, my attention during market hours is so consumed by work, coordinating projects on the getaway property, and basic household chores that I simply don't have the time to study the market (I can barely keep up with social emails and texts from family and friends during the week) or make investment moves quickly. And even if I did, would I be able to beat the market or would I, like nearly everyone except Warren Buffet, end up underperforming in the long run?
In The Simple Path to Wealth, JL Collins makes a strong argument for why even sophisticated long-term investors would optimize their portfolio by simply investing in a mixture of two low-cost index funds: a broad-based stock market index (such as Vanguard's "VTSAX") and a broad-based bond index (such Vanguard's as "VBTLX"). It is straightforward to match the market with low-cost index funds when they have expense ratios of about 0.04%, which are far lower in cost than the 1.00%-2.00% charged by typical financial advisors. If a financial advisor claims they can beat the market, cool, but they would have to beat the market above and beyond the cost they are charging you in order to beat the return you can get from a low-cost index fund.
JL Collins started his blog with the hopes of documenting his financial experience and advice to pass on to his daughter one day. He has actively traded stocks since the 1970s -- before index funds even existed-- and has lived through several terrible stock market downturns. He has seen firsthand how detrimental emotional reactions and impulse buy and sells can be to one's net worth, including his own. After he retired, he sat down to do the math and saw that if he would have only followed a low-cost index fund strategy of investing, he would have had ended up with a larger net worth. If I could only recommend a single personal finance book, it would be The Simple Path to Wealth by JL Collins. It is short, easy to read, experience- and research-based, and he explains the importance of having "FU money" and the beneficial "self-cleansing" nature of index funds.
I have always been a fan of low-cost index funds -- I first learned about their benefits over a decade ago from Suze Orman's books and TV show. I currently have 100% of every single workplace retirement account from my current and former employers invested in an index fund that most closely matches a total stock market index fund, depending on the portfolio offerings of each employer. With the vast majority of my total investments invested in index funds, I recently decided to use part of my Roth IRA as a playpen of sorts to experiment with individual stock purchases. After watching individual stocks for a few weeks, as my Tesla stock story shows, I am fast learning that this may not be the right strategy for me. Aside from the time element, I realize I do not have the risk tolerance or the "stomach" to see my hard-earned money fluctuate wildly, and prefer the smoother path of an index fund.
I have concerns of what the next couple of years will look like in the stock market, and while I can see the economic writing on the wall today, what matters for whether the stock market goes up or down and by how much is what, when, and how many investors overall will respond to new information. Because of this, I want to dollar-cost-average into the stock market and try to time the market. The best way for me to do this is find a way to automate the process.
Vanguard allows you to set up an automatic investment plan, but you can only automatically invest into one of their mutual funds. Lucky for me, my index fund of interest is the Vanguard Total Stock Market Index Fund "VTSAX." According to its prospectus, the investment objective of the VTSAX Fund is to "track the performance of a benchmark index that measures the investment return of the overall stock market." As you can see from the equity sector diversification snapshot, the VTSAX is heavily invested in Technology stocks as of January 2021.
I have invested in VTSAX over the years plenty of times before within my Roth IRA account, however, today was the first time I took a few minutes to peruse the list of 3640 individual stocks that make up the index. The larger the market capitalization of a particular stock, the larger its weight in the stock market index. In January 2021, the top 10 holdings made up 23% of the total net assets of the VTSAX, and were: 1. Apple, 2. Microsoft, 3. Amazon, 4. Alphabet (Google), 5, Facebook, 6. Tesla, 7. Johnson & Johnson, 8. Berkshire Hathaway (Warren Buffet's index), 9. JP Morgan Chase, and 10. Visa. These are names of stocks, some of which I already own, and others that I aspired to own "someday." I was starting to feel like a fool -- why was I spending so much time researching the top stocks when I could let the index fund do it for me? (Why don't we listen to our elders?!)
I dug deeper into the VTSAX and found the top 150 holdings (out of a total of 3640 holdings), and created a word cloud to visualize the relative weight these stocks represented in the index according to their market cap. I was surprised at how many names I recognized -- both as an everyday consumer and an interested investor.
Seeing these stock names in print has reinvigorated my interest in taking the low-cost stock market index fund route. I am excited to see whether, a year from now, the tech stocks will still be in the lead. Even within the top 150 holdings, I see signs of the pandemic's effect on the U.S. stock market with names like "Moderna" and "CVSHealth" making a showing. By investing in a total stock market index fund like the VTSAX, I don't have to worry about which way the wind blows because I'll own a share of every single publicly traded company's stock and be automatically more heavily invested in large winners than small losers.