Just about every morning, I spend time at the gym. Many mornings I read The New York Times on the Stairmaster, which I hate. The Stairmaster, not the NY Times.
One of the regulars at the gym is an older man, who happens to be a multi-millionaire. He usually likes to kid me good naturedly about the fact that I have all my money in index funds. In contrast, he is a stock jockey, who is always searching for the next great four-bagger. He is always eager to share just how successful his best picks have been. I don’t hear much about the losers.
But early this week, when the market was swan diving after the Bear Stearns takeover, my buddy looked panic stricken when we crossed paths. He owns big positions in Wells Fargo and Washington Mutual and he was trying to wrap his mind around the possibility of losing hundreds of thousands of dollars in one day. And that’s what happened.
Of course, playing in the markets is risky, but my friend’s investing strategy is much riskier than sinking money into index funds. Individual stocks are far more volatile than index funds that hold a broad swath of stocks. Through my index funds, I too own Wells Fargo and Wash Mutual, but I also own hundreds of other blue chips that can limit the damage when some of them explode.
Anybody who owns a diversified portfolio of index funds doesn’t have to worry as much about what’s happening in the market — as long as they don’t need to pull their money out anytime soon. Sure there will always be rocky times, but historically patient investors have been rewarded.
I’m providing the link to some model portfolios from Vanguard, which should help you get a handle of what kind of risks and rewards you may be comfortable with.
I’m going to leave you with one more thing to think about the next time you read a story about how scary the markets are. Volatility is perfectly normal. Here’s just one example:
During a 37-year period ending in 2007, the Standard & Poor’s 500 Index experienced a 1% change in value –either up or down — 23% of the trading days. Think about that the next time you vow to move all your investments into CD’s.