Why index funds work and picking stocks does not
🔸 Plus: We’re all eating baked potatoes now 🔸 Our marriage preferences are increasing inequality 🔸 Which is best: paying off your mortgage or investing in an ISA or a SIPP? 🔸
Your 2-minute guide to demystifying money and making you richer
The markets, year-to-date
S&P 500: 5,702.55 ⬆️ 20.24%
FTSE 100: 8,229.99 ⬆️ 6.59%
Bitcoin: $63,793.40 ⬆️ 44.31%
GBP to USD: $1.3312 ⬆️ 4.60%
GBP to EUR: €1.1925 ⬆️ 3.42%%
(as of market close on Friday)
Why passive investing always beats stock-picking
At Moneyin2, we keep encouraging you to invest your savings in index funds or exchange-traded funds that passively follow a broad market of major stocks, like the S&P 500 or the Nasdaq.
(The S&P is simply a list of the 500 biggest companies whose shares are publicly traded in the US. It contains all the international household names, like Coca-Cola, Apple, and Airbnb. The Nasdaq focuses more on tech stocks.)
The reason we recommend this is because the broad markets always beat the day traders, the stock pickers, the actively managed funds, and the professional money managers over the long run.
But why is this so?
Surely, an expert ought to be able to look at the market and make good guesses as to which companies will do better than others.
Yet the experts are continually humiliated as the broad market beats them, year after year. A study by S&P Dow Jones Indices showed that out of 2,132 actively managed mutual funds, not a single one — none, zero, nada — beat the market over a five-year period.
In some years, the experts do, in fact, come out ahead. But you need more than one-off successes. You need to come out ahead over the long run.
So it is worth knowing what the long run looks like, because that shows you why stock-pickers fail and why passive investors whose money follows the index always win.
To the charts!
JP Morgan recently published a lovely set of charts that illustrates this exact point.
Here are the S&P’s annual returns since 1994. You’ll notice that the average return is 9.7% — more than twice what you are getting with cash savings. Click on the chart if you want to make it bigger:
You’re not going to get 9.7% every year. It will go up and down. But that is the average.
So far so good — the S&P generally does well.
Protecting you from your own lousy choices
This second chart shows you how investing in the entire S&P 500 index protects you from your own terrible choices. It shows the number of companies in the index whose stock fell by more than 5% in each year. On average, 151 companies of the 500 lose 5% or more in any given year:
That means you’ve got a 30% chance of selecting a company that’s going to lose you 5% or more.
Notably, the S&P contains losers every single year — even in the good years!
Last year, for instance, the S&P rose a juicy 24% — yet 126 companies in the index were losers. You’re always at risk of buying one of the losers if you’re picking the stocks yourself.
That’s what index investing does for you — the performance of the companies that do well almost always eclipses the losers. And you don’t have to spend hours studying the financial disclosures of hundreds of companies, trying to figure out which are the good ones.
Remember, the experts do that — and they can’t beat the market either.
And for dessert …
Apparently we’re all eating baked potatoes now. Thanks to TikTok.
Should you pay off your mortgage or invest your cash in an ISA or a SIPP? A really useful article on how to think this through.
Our marriage preferences are increasing economic inequality. A new study says: “When my co-authors and I studied how marriage outcomes have affected inequality, we found that because people have increasingly been marrying someone more like themselves, that can account for approximately half of the increase in household income inequality between 1980 and 2020.”
Billionaire investor Ray Dalio repeated his warning that he fears for the future of democracy. It feels like the 1930s, he says.
How “breadwinner wives” who out-earn their husbands navigate success and marriage.
The Moneyin2 Guide to Wealth
The Moneyin2 Guide to Wealth will get you the biggest return on your savings by maximising cash matches from your employer, free cash from the government, and shielding your investment gains from tax. It takes you step-by-step through the world of pensions, SIPPs, ISAs and ETFs — all in plain English.
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