Curious about whether to invest in Index Funds? You’re in the right place.
In Episode 5 of Stocks4Docs we look at the differences and explore the pros and cons of each.
Dr. Sam Shen is our guest expert this week. He’s an Associate Professor and Vice Chair of Clinical Operations and Quality in the Department of Emergency Medicine at Stanford University. At Stanford Health Care, he serves as a Patient Safety Officer/Associate Chief Quality Officer.
Sam discovered a personal passion for investing early on in his career, and now helps others understand how to educate themselves… “I got to the point where I started to really think, how can I put some models out there to teach others how to approach investing?”
When it comes to learning about what it means to identify successful companies, Dr. Shen has this to say:
“At the end of the day, investing is trying to identify trends or successes in companies that then ultimately become profitable.”
It sounds easy when you say it like that, but let’s take a look at how to start analyzing investment options and making decisions. A lot of this also involves decisions on asset allocation… basically look at it as how to utilize your capital to get the best return. If you think of yourself as a business, you have revenue or income… you have expenses… and you have a profit, which when all is said and done is your savings. You always want to be thinking of how to manage that revenue so that it’s higher than expenses, and then maximize what you have leftover as savings.
Know Your Basic Investment Options
When you’re starting out, one of the most basic fundamental strategies you can use is to invest in index funds. These funds have proven over the years to serve investors just as well as if you were to use a professional manager. It’s really the one thing that’s shown over and over to really work.
An index fund is a collection of individual stocks. As an investor, you can choose between buying an individual company’s stock, or buy into one of these collections of stock. It’s called an index fund because it represents the economy.
The most common one you’ve probably heard of is the S&P 500, or the Standard & Poor’s 500 Index – it represents 500 of the largest companies in the US. They represent the U.S. economy, and investing in the index means you are investing in all 500 companies. The expectation is that over time, those 500 companies will do well, and therefore your index fund does well. Other funds are based on other specific sectors, like healthcare or tech, but all with the same idea of spreading out your investment across a group of stocks that perform solidly over time.
Of course the returns on these still go up and down a bit each year, but historically they’re around eight to twelve percent. Compared to .05 to .5 percent returns on a checking or savings account, you can see that this is a huge difference year over year.
Obviously there are times when a savings account makes sense, for example when you’re getting ready for a big purchase like a house. But if you don’t need to touch the money for ten to fifteen years or more, then a steady investment like an index fund makes better sense.
Once you’re set up in index funds, you can look to that as being a foundation for building the rest of your investments. You can take some of that revenue and start looking for individual stocks to delve into. Individual stocks are likely to get you higher returns, but they also come with higher risk, so you want to protect yourself by getting the basics taken care of first. This is also where those four principles of value investing come in that we’ve discussed here previously.
The Best Thing You Can Do
No matter what stage of life or your career you’re in, the best thing you can do for your financial investments is to begin.
Engage at whatever level you’re comfortable, even if that’s $10 a week for now. Once you start putting your money in, you’ll find yourself naturally getting curious and more interested in the stock market and related news reports.
Even if you discover you’ve got very little interest in the whole thing, at the very least you’ll have put some money into an index fund and years from now will be better off.
Sam Shen is an Associate Professor and Vice Chair of Clinical Operations and Quality in the Department of Emergency Medicine at Stanford University. At Stanford Health Care, he serves as Patient Safety Officer/Associate Chief Quality Officer. Dr. Shen received his Bachelors at Stanford University and his MD and MBA from UCLA. His emergency medicine residency was completed at Beth Israel Deaconess Medical Center in Boston.
Dr. Shen’s academic interests include digital health, quality improvement and patient safety.