Stock market investing has surged in popularity over the last five years. This is largely because stocks have rallied strongly and earned back all of the losses that were seen during the collapse of 2008. It seems as though the Dow Jones Industrials and the S&P 500 are making new record highs every time we turn on the financial news. So, what is the best way to capitalize on these trends? Is there still money to be made using index funds? For those willing to take a long-term outlook, the answer is a clear “yes.”
Index Funds Defined
So, what exactly is an index fund? An index fund is an investment instrument that tracks the performance of a benchmark stock index. Key examples here include the S&P 500, Dow jones Industrials, NASDAQ, and Russell 2000. Index funds provide broad exposure to a large number of stocks and a wide variety of market sectors. Ideally, when selecting a fund you want to fund instruments that have minimal portfolio turnover and low operating expenses.
This essentially means that the management costs will not eat into your profit potential and that the fund itself does not make many changes in the stocks that make up the fund. Not all index funds are created equal, so these are factors that will need to be considered before you start investing any real money in these vehicles.
Taking a Long-Term Outlook
The next factor to consider is the length of time you plan to be invested. When we look back at stock market history, we can see that fortune clearly favors those that establish positions for the long-term. One of the biggest mistakes that new investors tend to make comes when thinking it is easy to “time the market” and take short-term day trades as a strategy for success.
But, unfortunately, there are very few examples of traders that have actually been able to make these types of strategies work in any consistent way. Stock markets are notorious for experiencing short-term price fluctuations that are volatile and unpredictable. It is a great mistake for new investors to think that they can overcome these historical tendencies — and when this is approached in the wrong way significant losses can accumulate quickly. It is a much better idea to stick with the broader, long-term trends as this will generally produce the most substantial returns.
Broad Index Trends are Generally Positive
Of course, it cannot be argued that any “buy and hold” strategy will profit in the stock market. There are certainly months — and even years — where the trend is negative and losses can accumulate. But when we look back through history it quickly becomes clear that most years are positive for the stock market and that conservative strategies tend to profit over time.
Let’s consider the S&P 500, which is the most commonly watched stock index. On average, the S&P 500 will produce annual gains of around 12%. This is not something that can be said for individual stocks. So for those looking for investment strategies that have truly proven themselves over time, there is no better alternative than to choose a commonly watched stock index and allow the broader market trends to establish themselves. An added benefit for this type of strategy is that it takes most of the guesswork out of choosing individual stocks. It is also much easier than looking to time the market and benefit from short-term trends.
For these reasons, investors can remove a good deal of risk when investing in a stock index with a long-term, conservative outlook. Short-term strategies are much more likely to put your retirement savings at risk — and if you are unable to accurately time the market you could encounter losses that should have been avoidable.