284 | JL Collins Returns
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The Self Cleansing Approach to Index Funds
In an S&P 500 fund, 30% of your net worth is tied up in a small group of companies disproportionately in the tech sector. At some point, I would guess that technology is going to fade away and it might be replaced with something else at the top. That's part of the self cleansing process. Your hypothetical investor who owns, say, those 10 top technology stocks and is just going to hold them is going to get the fading effect without the new companies taking their place.
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- When it comes to investing strategies, one of the most influential books available claims that if you keep it simple, you'll actually do better.
- Here to talk about the philosophy behind his investment strategy is one ofChooseFI's most requested guests, JL Collins, author of The Simple Path to Wealth, and popular blog series, The Stock Series.
- The influence of JL Collins cannot be overstated. The content he produced changed the trajectory of Brad's life and made him feel comfortable investing.
- In 2011, JL's daughter was in college but was turned off of all things financial after he pushed too hard. Because he wanted her to know how to invest and handle money, he decided that he needed to write it down for when she was ready.
- It was suggested that he archive the advice in a blog and share with friends and family. Much to his surprise, strangers began to find it and he quickly had an international audience.
- The book came out of the growth of his blog. Always having the ambition to write a book, The Simple Path to Wealth became a more organized and concise compilation of his blog articles. Four years later, 2020 has been its best selling year and the success has greatly exceeded expectations.
- Readers have responded positively to the authenticity of his writing, which he believes is because he was writing for his daughter. Now that she is a young adult, she's been receptive to the information and is now on board with the strategy presented.
- For Brad, investing always seemed like something that required thousands of hours of understanding and special insight until he began reading The Stock Series on JL's website. It gave him hope that he had a chance at long-term success for wealth that would last for many decades.
- JL acknowledges the method in the book is the last and best method he came to after going through other iterations involving picking stocks and actively managed funds. The other methods work, but they are harder and a lot less powerful than a low-cost index fund.
- JL says this method isn't just for beginners, it's the best way to invest for everybody. The most powerful way to invest is the simplest and the easiest.
- He realized that not everyone wants to think about investing the way he like thinking about it. Most people know it's important, but have more important things they want to do with their lives. His approach allows them to set it and forget it.
- The investing world is complex by design because the more difficult it is to understand, the more Wall Street can charge in fees.
- Jack Bogle, the founder of Vanguard, was the first one to invent index funds and talk about index fund investing. Because outperforming the market as a whole is extraordinarily difficult, only 20% of fund managers in any one year can do it. After 30 years, the percentage of fund managers that can do it is less than 1%.
- Even Warren Buffet wrote in his 2013 Berkshire Hathaway shareholder letter that he would advise the trustee of his estate to invest 10% in government bonds and 90% in a very low-cost S&P 500 index fund.
- A mutual fund, or similarly, an Exchange Traded Fund (ETF), takes money from a lot of investors and lumps it together to invest it in something.
- The S&P 500 index invests in the 500 largest US companies that make up the S&P index, while an actively managed mutual fund may focus on a different parameter, such as energy or technology.
- An actively managed fund attempts to pick stocks that over time will outperform the index which is an expensive route and reflected in what the investor pays for the fund, called the expense ratio.
- Every fund has an expense ratio, but what matters is how high it is. Because index funds don't have those expensive fund managers, the fees are very low. JL's most recommended Vanguard fund, VTSAX, has a 0.04% expense ratio. Actively managed funds average 1%.
- The impact 1% has compounded over time is dramatic. On a $1M portfolio, you may be withdrawing 4%, or $40,000, each year, while 1%, or $10,000, goes into the pockets of those managing your portfolio. That's money not going to you or working for you by growing over time.
- In an article Brad wrote several years ago, he looked at the impact fees had on an investment portfolio. With a 1% expense ratio and/or a 1% fee for assets under management, the fees over a 40-year period cost millions of dollars.
- Owning index funds means you own all of the companies within that index, both the winners and the losers. VTSAX is Vanguard's total stock market index fund which invests in virtually every publicly-traded US company.
- There is very little difference between VTSAX and the S&P 500 index fund since VTSAX is capweighted, meaning it owns more of the largest companies. Only 15-20% are small or mid-cap companies.
- JL loves index funds because they are self-cleansing, meaning that you benefit from the winners while the losers drift away. The worst you can lose is 100% on a company, but you can gain 200% or even 1000% with the winners. Tesla is a great example of the upside.
- An S&P 500 index or total stock market index fund is essentially the same regardless of which brokerage firm it is purchased from. JL prefers Vanguard because it is structured where its interests are identical with the investors. The investors own the Vanguard funds which helps to continually drive down costs.
- The impact of changing from a fund with a 0.04% fee to 0.02% or even 0% isn't tremendous. JL prefers to stick with a company like Vanguard that favors the investor over the owner.
- Another thing Vanguard is trying to do is make investing more accessible. They have lowered the minimum investment for VTSAX from $10,000 to $3,000. Those without an initial $3,000 to invest can opt for VTI, the Exchange Traded Fund version of VTSAX.
- VTI is primarily a trading vehicle that any amount of money may be invested in. Like a stock, buy and sell orders are executed immediately, while index funds prices are set at the close of the business day.
- Traditionally, investors have needed to purchase whole shares of ETFs. Companies like M1 Finance have made it possible to buy fractional shares.
- It would be wonderful if we could time the market, but it's more important to have time in the market. The best way to lose money is to try and dance in and out of the market. Trying to time the market does not work.
- When the market began to drop during the beginning of the COVID pandemic, JL held strong in his conviction that no one knew what the market was going to do. The important thing to do is to stay the course.
- You have to expect market drops during your investing lifetime. JL says no one should follow his advice unless they are absolutely clear that they will not sell when the market drops. Selling is not an option. Market drops are temporary.
- After Black Monday in October 1987, JL, despite knowing better, lost his resolve and sold near the very bottom of the market. He didn't buy back in until the market had completely recovered. Now, market fluctuations don't bother him.
- Roughly 20 companies make up 30% of your holdings in an S&P 500 index fund. Any company or sector that rises to the top means you'll own more of it. When those companies fade away, the individual who owned them in an index fund will fare better than an investor who owned them as a single stock.
- The most powerful companies today will not be the most powerful companies decades from now. Of the original companies making up the DOW, not a single one remains in the DOW. With an index fund, you never have to worry about what's fading out or what's rising. You will always be there.
- Earn $1,000 in cashback with ChooseFI's 3-card credit card strategy.
- Share FI by sending a friend ChooseFI: Your Blueprint to Financial Independence.
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