The Benefits of Buying into an Index Fund

investment portfolio

21%.

That’s what I’ll be telling a friend of mine on the weekend.

That’s the return he could have made in a few months, had he not sold his Telstra Corporation Ltd [ASX:TLS] shares.

I applauded him for selling though.

Sure, he missed out on some quick returns. But he didn’t want to be analysing Telstra’s financial reports and staying up to date on industry news.

He just wanted to buy an asset and forget about it.

It’s why I was so happy he decided to buy an index fund. It’s exactly the kind of purchase that suits his investment experience and wants.

There are no certainties in the market. But buying the market (it depends which market) is something that Warren Buffett often instructs his followers to do.

Consistently buy an S&P 500 low-cost index fund,’ he told CNBC. ‘I think it’s the thing that makes the most sense practically all of the time.

So why aren’t more novice investors buying the market?

I have no idea. Maybe they think they can do better than the average.

Maybe they’re envious of those making far more than the average. Or maybe they just don’t like the idea of trying to create wealth slowly.

So they choose an alternative.

They jump in and out of stocks they don’t understand, betting that prices will go up or down.

None of this is to say there’s anything wrong with a bit of speculation.

But an active strategy has its fair share of downsides…

Free Report: The five most potentially lucrative income stocks trading on the ASX right now. Get all the info here.

When a rising price means nothing

I hope I haven’t turned you off from active investing.

As Joel Greenblatt told employees of Google:

Even Warren Buffett says the vast majority of investors should index [buy the market], and I agree with himThen again… Warren Buffett doesn’t index, and neither do I.

That may be because both men have shown they can earn returns far better than the market. Of course that doesn’t mean everyone can.

But back to Telstra…

Why has the stock risen more than 20% from its low this year?

Everyone was so negative on the stock just months ago. What has changed now?

Buying Australia’s largest telco near all-time lows might be one answer.

However, I believe a lot of investors might have piled simply because a rising price reaffirms the view of a bargain price.

Take a look at what Switzer wrote as Telstra rose from $2.62 to $3.27:

What happened to Telstra is an important lesson for anyone wanting to build wealth through shares. I’ve often told my subscribers to the Switzer Report, our investment and stock picking newsletter, that quality companies that are beaten up by an overreacting stock market can be an opportunity to buy what looks like the wrong stock at the right time.

I agree with Switzer.

But a rising stock price doesn’t necessarily prove the point, especially in such a short time.

Investors buy and sell stocks for all types of reasons.

Many will base their decision on earnings. But others are buying for a whole bunch of other reasons.

And because the market is not always rational, it’s common to see stocks like Telstra rise in the short-term only to fall over time.

I have no special insight into the future of Telstra’s stock price. But, for my friend and other investors like him, a missed opportunity in the short-term generally doesn’t matter.

If you want to have a set and forget strategy without too much involvement, you could always consider buying the market and sitting back.

Want more than a dividend cheque?

As you might know, Telstra is now investing in their future. Surely this will mean their tasty dividend will come down even more?

What will Aussie income investors do?

Maybe they’ll pile into miners. Reported by the Australian Financial Review:

Australian investors are set to share in a record $18.9 billion dividend bonanza this month as the big miners have emerged as the market’s new dividend stars, offsetting more miserly payouts from embattled blue chips like AMP and Telstra.

‘…Although investors will have to be cautious around the commodity cycle, if the miners are able to maintain their dividends for a few years at current levels that will win back investors. In the last 18 years, BHP has only cut its dividend four times, although on the last occasion it was a necessarily savage event.

Your friend,

Harje Ronngard,
Editor, Money Morning

PS: Income specialist reveals five stocks he calls ‘…the best dividend paying stocks on the Aussie market today.’ Find out which stocks he picked here (free).

Harje Ronngard

Harje Ronngard

Harje Ronngard is the lead Editor at Money Morning. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.

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