- The rapid rise of the FAANGs has influenced the performance of index funds.
- Indices tend to adjust over time.
- For long term investors (10 to 50 years before retirement), the power of compound interest is so great that getting started now shouldn't be a source of worry.
- For those who are nervous about the current level of the markets, dollar cost averaging into a diversified portfolio may be a good way to reduce your anxiety.
The current level of the stock market is an enigma for many. Stocks appear to be reflecting rosy future growth projections and many large cap index funds are seeing their returns driven primarily by the growth of stocks like Apple, Google, Facebook, Netflix, Tesla, Microsoft and Amazon. For any new investor, this frothy environment represents a difficult starting point for their portfolio. The good news is that if you have a long term time horizon, namely more than ten year and up to 50 years depending upon your current age, the stock market is still a great tool for you to help grow your savings. Distortions within indices tend to be temporary and over the long term the index will readjust to reflect the performance of the index asset class.
Since we don't know when or what will make the markets fall, it is impossible to successfully time the markets over the long term. In order to overcome the fear of buying at the wrong time, many investors would benefit from creating a process to help them invest on a periodic basis. Instead of investing $1000 all at one, break it into smaller chunks, say of $250, that you can invest each quarter (or monthly) for a year. With low fees at most brokerage firms, the cost of making small investments should be close to zero. Many of us do this effectively with our 401(k) contributions throughout the year. You can also do this for your taxable investments. Also, by diversifying your portfolio away from one segment of the market you can reduce volatility in your portfolio and increase long term returns at a lower level of risk. This means allocating across large cap, mid cap and small cap stocks both locally and internationally, as well as across both US and international bonds.
Investing shouldn't be exciting. Having a boring plan that you stick with will set you on the path to growing your wealth. Speculating is exciting. Don't speculate unless you can withstand the potential loss of your funds. Finally, seek to use broadly constructed, well-known index funds and ETFs to get exposure to the market. In this manner you will be getting market rates of return while minimizing your operating expenses. ETFs will also help you better manage tax consequences of capital gains distributions from traditional mutual funds, as with ETFs you control when you take the gain. Controlling operating expenses and unnecessary taxes will help your portfolio grow and benefit from the power of compound interest.