Simpler is better. It also doesn’t mean you have to settle for subpar returns.
Are you looking for stronger returns on your money but aren’t quite sure where to start? If you’re thinking about doing it with stocks, then you’re looking in the right place. The stock market’s long-term rate of return is stronger than what’s achievable with alternatives like money markets, bonds, commodities, or real estate; the market’s average annual return stands right around 10%.
If you don’t have any experience with stocks, however, the idea could also be daunting. Picking stocks certainly seems more than a little complicated from the outside looking in.
It doesn’t have to be, though. In fact, there’s a simple solution that’s perfectly suited for newcomers. This option doesn’t require any special knowledge or experience, nor does it require any ongoing maintenance or monitoring. The investment? A stake in the SPDR S&P 500 ETF Trust (SPY 0.66%).
But first things first.
The SPDR S&P 500 ETF Trust’s two top attributes
If you don’t have any investing experience, an explanation of the SPDR S&P 500 ETF Trust’s two most important attributes is in order.
First and foremost, it’s an exchange-traded fund (ETF). These are just baskets or bundles of stocks that are bought and sold just like individual stocks such as Coca-Cola or Microsoft. Rather than achieving the diversity you would by owning a variety of individual companies, with an exchange-traded fund you own a piece of all the stocks held within the ETF with a single trade. It’s an attractive option simply because managing a bunch of individual stocks can get very tiresome very quickly.
Second, it’s an index fund. That just means the stocks it holds are the exact same names in the same proportion held by a corresponding market index.
In this case, the index in question is the S&P 500 (^GSPC 0.70%), which holds 500 of the U.S. stock market’s biggest and most important (more or less) publicly traded companies. If Standard & Poor’s makes any additions, subtractions, or adjustments to the index, then State Street Global Advisors — which manages this SPDR ETF — will adjust its holdings accordingly. This means the ETF’s shareholders won’t have to do anything themselves to keep their investment up to date. And that’s why it’s the kind of investment that you could hold forever as your only holding.
The thing is, there’s a strong argument to be made for doing exactly that.
Beating the market is hard. Like, really hard.
It’s probably not the exciting path to riches you were hoping to take. The whole idea seems a bit boring, in fact — you’re never going to beat the market if you’re only positioned to match the market’s overall performance. And for all intents and purposes, the S&P 500 is “the market.”
This is still the smartest path for most investors, however, and especially for novices.
See, no matter how smart you are or how deep you dive into the art and science of picking stocks, it’s unlikely you’ll ever consistently outperform the S&P 500.
Surprised to hear such a discouraging suggestion? Consider this: Most trained and experienced mutual fund managers (mutual funds are a lot like ETFs, except they’re only bought and sold at the end of any given trading day) typically don’t beat the market either. Number-crunching done by Standard & Poor’s indicates that over the course of the past three years, nearly 80% of the large-cap mutual funds available to investors in the U.S. underperformed the S&P 500. For the past 10 years, more than 87% of U.S. large-cap funds trailed the S&P 500 index. For the past 15 years, 88% of these mutual funds couldn’t even keep pace with the S&P 500.
And for the record, the rare fund that manages to outperform the market in one of these time frames usually isn’t one that outperforms it in another time frame.
Image source: Getty Images.
Chew on that for a moment. These well-trained and well-equipped professionals usually can’t beat the market despite devoting a full-time effort to doing so. If they can’t do it, what hope does a part-time amateur have to do so?
What gives? These managers are making the same mistake many individual investors make, which is making ill-advised timing decisions with individual trades. Timing the market isn’t just nearly impossible to do well. It’s often counterintuitive to the point of being impossible.
That’s not to say it can’t happen. Small investors have an edge over most mutual fund managers: their smaller size. You can get in and out of positions without single-handedly moving a stock’s price in a disadvantageous way. Funds have that problem.
Nevertheless, there’s a reason most investors don’t beat the market for very long. The higher-odds play here, therefore, is accepting average market returns. You could certainly do worse.
Start here … and maybe finish here
The good news is, buying the SPDR S&P 500 ETF Trust now doesn’t mean it has to be the only investment you’ll ever own. If you wish, you can add individual stocks to your portfolio later as you add money to your account. You can also sell some or all of your stake in this index-based ETF down the road and use those proceeds to purchase other picks. There’s a universe of options out there.
As a starting point for anyone without any real stock-picking experience to speak of, however, simpler is better without being any less productive.
So, start with the SPDR S&P 500 ETF Trust if you’re willing to make a multiyear commitment to it. Then learn more about investing while you’re keeping pace with the broad market. Then add individual stocks to your portfolio around this core holding as you become more comfortable with picking stocks.
Or, don’t bother doing anything beyond buying and holding this exchange-traded fund. Plenty of investors are perfectly happy with that very choice.
