Own the Economy

Buying and selling individual stocks is risky. Instead, if you buy and hold index funds, you can essentially own the economy, reduce your risk associated to any single company, and avoid paying costly fees to fund managers who actually lose your money more than half of the time.

A quick primer on the markets, stocks, and bonds. You can make money in one of three ways:

• selling a product
• selling a service
• loaning someone money (who will pay you back more at a later date)

People do this individually, companies do this as a group, and the economy does this as a whole. You can own the economy by buying stocks and bonds. When you buy a stock, you own part of a company that sells products and/or services. When the company makes a profit, you get some of it. When you buy a bond, you’re lending a company or the government (perhaps a local town) money that they promise they will pay back with interest. Stocks and bonds are traded on exchanges that find buyers for the sellers.

Buying stocks for individual companies or bonds for individual bond issuers is risky. If that one company goes under (think Enron) so does all your money. Sure you could land on a lucky winner, but if you want to gamble, go to Vegas – it’s more fun. What if you could own the whole economy instead? That way, you are buffered from the whiplash of the individual companies and are only “betting” on the American economy. If American business does well, so do you. And it has done well for the past 86 years, with an average return of 11%. One dollar invested in 1928 would be worth $126 today.

Lucky for you, you don't have to go out and buy each separate stock. Mutual funds do the work for you. An index mutual fund is a fund that holds a group of stocks that automatically track a large market, such as the S&P 500 (stocks from 500 large U.S. companies). The same is true for bond funds. An index bond fund invests in thousands of bonds and tracks the overall US bond market return. Index is the key word. Never buy anything else. Always index stock fund and index bond fund.

Actively managed funds are evil because it’s nearly impossible to guess what stock or bond will do better over a long investment period (think about flipping a coin – it’s easier to guess it right once but to continually guess it right again and again gets exponential harder). It seems like we should be able to pay smart people to crunch numbers and research companies to predict the markets so that we will know when to buy and sell, but history has definitively shown that this can not be done consistently for nearly all investments proffesionals who have ever tried .