We gave you a preview last time, and here is everything you need to know about index funds!
Lots of ideas in this video are credit to Tony Robbins in his book 'Money: Master the Game'. Be sure to add it to your reading list!
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So far, we’ve gone over the different types of investment options you might see at a bank. Things like GICs, Stocks, and Mutual Funds. We’ve also discussed some rules to keep in mind as you approach investing.
As we mentioned before, our favourite investment option is one that is low risk, but provides medium to high rewards. Remember Index funds? They are a type of mutual fund that imitates certain stock indexes, hence the name.
In Canada we have one main stock exchange, which is the Toronto Stock Exchange, or TSX. You can go on Wikipedia right now and look at a list of stocks that are traded on that exchange.
You can’t actually buy the TSX, but some banks have created a mutual fund that is very close to holding all of the stocks listed within the TSX. There are mutual funds that mimic other exchanges like S&P500 and the NASDAQ.
Because index funds represent the stock exchange, and the stock exchange’s composition doesn’t change much, index funds are what’s known as “passively traded”.
On the other hand, you have mutual fund managers who are actively buying and trading stocks to get better returns. They are trying to “beat the market”. These mutual funds are “actively traded”.
So with passively traded funds, the fees associated with buying index funds are much lower, usually less than 1% of total assets. Actively traded mutual funds hover around the 2% mark.
Wait, 1%, 2%, of what? These fees are asset-based, meaning it’s a percentage of what you have invested.
This means that if you have $10,000 invested in an index fund, you are paying $100 a year in fees. Compare that with paying $200 a year on a 2% fee mutual fund.
Index funds are recommended by most billionaire investors such as Warren Buffet because through statistical data, they perform better than most mutual funds offered to you by your financial advisor, yet charge significantly less management fees.
Here’s a fun fact: 96% of all professionally managed mutual funds don’t beat the stock index. That means you have a 4% chance to beat the market when you choose a mutual fund offered to you by a financial advisor.
Let’s imagine you went to the casino to play blackjack. The goal of blackjack is to beat the dealer’s hand, to get as close to 21 as possible without going over.
If you get two face cards right off the bat, you have 20 points, which is a great hand. However, if the idiot inside you says “hit me”, in hopes of getting an ace, you only have an 8% chance of getting one.
So, think about it, you are two times more likely to get an ace in blackjack then you are to outperform an index with a mutual fund.
Why would you consider putting something so important as your life savings into something with such a low chance of success?
We’re not saying you’ll lose your money in mutual funds, but the index, and more specifically index funds, have been proven to perform substantially better in the long run, in both market booms and crashes.
So why do banks promote mutual funds so much? Well remember that you’re paying a really high fee to hold these mutual funds, and banks are a business too.
Your financial advisor becomes a salesperson when they recommend funds for you because they are being told by their manager and company to promote certain funds. So be sure to do your research, and in later videos we’ll reveal how you can ask the right questions to your financial advisor.
Along with stock index funds, there are bond index funds as well. These follow the same concept in that the fund will have as many different types of bonds in it as possible.