Investing is simple to learn, but it can be very hard to master. I’ve made my fair share of mistakes, particularly when I was just starting out. Instead of taking a measured approach and trying to focus on the long term, I jumped in with both feet and did a lot of things that weren’t good for me financially.
It would have been much better if I had bought a broad-based index fund, like SPDR S&P 500 ETF (NYSEMKT: SPY). Here’s why I think beginner investors should do this instead of what I did.
Thankfully, I didn’t have a lot to lose
When I started investing, there was no such thing as an exchange-traded fund (ETF), though Vanguard had by then popularized the index fund. Still, I wasn’t interested in an index fund back then. I wanted to find the trick that would get me rich — fast! There is no such trick, but it took me a lot of failed attempts to learn that hard truth.
Luckily, I was fairly young when I started investing, so I didn’t lose too much money as I learned. And I had enough success to keep me interested. Some investors get burned and then turn away from investing, choosing to avoid one of the most powerful tools for building long-term wealth. The compounding that can be achieved by investing in stocks would be difficult to impossible to replicate via any other saving vehicle.
So what should I have done, and what do I suggest new investors do today? Buy a broad-based index-focused ETF like SPDR S&P 500 ETF. You could also buy an index mutual fund, like Vanguard S&P 500 Index Fund (VFIAX). They do the same thing, just in slightly different ways.
The S&P 500 is a curated index
There are a few reasons for the choice of investments in the S&P 500 index as a starting place. The big benefit of the S&P 500 index as a base for an ETF or mutual fund is that the constituents, roughly 500 companies, are hand-selected to be representative of the broader economy.
In other words, a group of human beings have examined the stocks before they are added to the index, which also includes ensuring that they are, at the time of inclusion, large and reasonably strong financially. It wouldn’t be fair to suggest that you are only buying the cream of the crop with SPDR S&P 500 ETF, but with one investment, you are investing in a broadly diversified list of important companies.
The index is also market cap weighted, which means that the largest companies get allotted more capital. Generally speaking, the largest stocks tend to be the best-performing stocks, so you end up more heavily weighted in the stocks that are doing well.
While this is true most of the time, during transitions from bull markets to bear markets, having more assets in the top bull market performers can leave you exposed to the stocks that pull back the most. But, over time, the positives of market cap weighting generally outweigh the negatives.
Meanwhile, both SPDR S&P 500 ETF and Vanguard S&P 500 Index Fund are exceptionally cheap to own. SPDR S&P 500 ETF, the first ETF ever created, has an expense ratio of just 0.09%. Although there are cheaper ETFs to own, this is a very low expense ratio. Vanguard S&P 500 Index Fund’s expense ratio is even lower, at 0.04%.
The benefit of choosing SPDR S&P 500 ETF is that you can trade it all day like a stock, while mutual funds can only be traded once a day at the end of the day. The biggest benefit, however, is going to be the fact that, with either of these index products, you will not underperform the broader market, which is generally tracked with the S&P 500 index. Of course, you won’t outperform either, but with one simple investment, you have a solid foundation from which to learn and grow as an investor.
For example, you could examine the list of holdings to find a company you know something about and then start researching the stock. Apple, Procter & Gamble, and Disney would all be good starting points for this. Remember, if they make into the S&P 500, they are large and economically important businesses, which are the types of stocks new investors should focus on.
When you find a company whose business you understand well and that you think will be a good long-term investment, you can buy some shares (perhaps selling just a little of the S&P 500 fund you bought). Dip your toes in and track the stock for a little while until you get your feet wet. If you are comfortable with and enjoy investing, then buy another stock.
If you aren’t comfortable and don’t enjoy investing, sell it and put the money (and future savings) into the SPDR S&P 500 ETF, and you’ll be just fine. There’s no need to do anything more with equities than this.
SPDR S&P 500 ETF is a core holding
It is easy to buy and sell stocks. It is much harder to be a long-term investor because there is a learning curve to find the investing style that works for you. There’s also a material emotional component that you can’t fully explain to someone who hasn’t owned stocks through a bear market.
But by starting out with a broad-based index product like SPDR S&P 500 ETF or Vanguard S&P 500 Index Fund, you get in the investing game without taking on undue risk. From there you can take your time and learn, which may eventually lead you to a portfolio of individual stocks, a hybrid of an index product and some stocks, or you could decide that you prefer to keep things simple and only want an index fund.
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Reuben Gregg Brewer has positions in Procter & Gamble. The Motley Fool has positions in and recommends Apple, Vanguard S&P 500 ETF, and Walt Disney. The Motley Fool has a disclosure policy.
How Should a Beginner Invest in Stocks? Try This Index Fund. was originally published by The Motley Fool
