In general, I do not select individual stocks, but instead, I use investment funds.
When you start investing in the stock market it can quickly become confusing. Fortunately, we have some good opportunities today.
Investment funds make so much more sense after you have considered the possibilities. Particularly the time spent.
In the following, I especially cover index funds because it’s my preferred way to invest in the stock market.
Let’s look into it 🙂
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What are investment funds?
Basically, investment funds are a form of collective investment.
The funds are combined together and are managed by some professional (like the Danish SparInvest or the popular Vanguard from the US).
They essentially ask for a fee to do the investment for you (sometimes fixed, sometimes performance based).
4 key reasons to use investment funds
➀ Low entry and no minimum investment
The minimum investment required is usually nothing or very low (e.g. €500).
It gives you the opportunity to start out with a small amount or pay a small amount on an ongoing basis.
I have set up an automatic payment every month with a certain amount. It’s really nice that I can determine the amount myself.
➁ Diversify and minimize risk
You can invest in several investment funds to diversify your investment portfolio.
You will then have a mixed variety of stocks and this will minimize risks.
I have 2 index funds right now, one of which has a global focus, while the other has a local focus here in Denmark. This gives a good spread for me.
It’s also much easier to handle than to choose different stocks in several sectors and regions.
My plan is to have about 35% of my investment portfolio in funds.
On top of this, within the investment fund itself, investments will be diversified.
The risk management will be even more sophisticated as the fund manager’s experience and knowledge will be of great value to you.
➂ Better returns than stock picking
It requires a lot of knowledge to choose the right stocks.
If you have too much placed with a single company then it can have quite significant consequences for you if a situation arises.
Therefore, it will be beneficial for most people to choose investment funds because they often give some fairly good returns from their well-diversified portfolio.
You can compare their returns over the past five years with how the market has evolved. This is a good indication of their performance.
➃ Low transaction costs
It’s very important to be aware of the transaction costs because they literally reduce the return.
If you invest small amounts in individual stocks it will be too costly. In contrast, the average transaction cost of investments in a fund is very low.
In my index funds, there are actually no costs associated with a new investment. This creates some very good conditions as an investor. However, they still need their annual administration costs.
Best funds to invest in for financial independence
➂ Mutual funds
- Give you access to professional managers and they will actively take care of the investment.
- The minimum investment is often higher than ETFs.
- They follow a detailed prospectus (disclosure document)
- They issue and redeem shares daily.
- Always accept investments and can fulfill the demand.
- Cost is often higher.
➁ Exchange-traded funds
- Managed passively. They track a specific index (such as the S&P 500), specific asset or basket of assets.
- ETFs are traded on the stock exchange like a normal share of stock.
- Entry position is very low. You can start with a small amount.
- Low expenses involved (under 1% most often).
There are also hedge funds, but I consider them high risk. You can also invest in “Investment trusts” (closed-ended funds) but they are not so common outside the UK. Therefore I didn’t include them here.
Here is my favorite fund…
➀ Index funds
Index funds are my is my favorite investment fund and they have similarity with ETFs.
It’s not about beat the stock market but rather to be the stock market.
Investor Warren Buffett also talks positively about averaging out your risk across all stocks within a market, rather than picking out individual stocks.
It makes it a safe investment with decent returns – something ideal for retirement.
It’s the low turnover and high passivity that makes it so effective.
Investment funds like index funds are also liquid. This means that your money isn’t tied up – you can buy or sell as you wish.
The right choice in a busy life
On top of having a job and a family life, it is important to factor in time as a cost, not just money.
We are all predisposed to make mistakes, and spending the time to make sure target investments are perfectly understood is really time-consuming.
Index funds require very little effort from you compared to conducting your own analysis on specific stocks.
It’s nice to relieve the stress and pressure from our investment decisions by having a simple and reliable index fund.
What to look for when searching for a good index fund?
You can narrow it down by creating a list of ones with low expense ratios. The average expense ratio of index funds is around 0.20% in the US.
On top of this, you can rule out any that require a load fund. It means you can sell without paying a commission (another fee that can be avoided).
Personally, my index funds have an annual cost of 0.5%.
Deciding on a market you want your fund to reflect is also important. The S&P 500 is by far the most popular due to its fantastic long-term growth.
There are some basic investment principles that help decide: for example, low cap markets tend to return more, but they are riskier.
This is something to bear in mind, but the bottom line is always publicly available – it is easy to view the past performances of each fund and make your decision.
Finally, look for promotions 😉
Often brokers will provide bonuses for new investors. This is definitely something to consider.
For example, mine has an agreement on no brokerage costs for investors.
Investment funds can help you achieve financial independence
Building up enough income-generating assets is the key to financial independence but you should also be very aware of the asset allocation.
I think Investment funds (especially index funds) are a great choice when you want to achieve financial independence.
The good thing is your money isn’t tied up with investment funds, which is great for financial independence, as this can kind of act as an [highlight]extra[/highlight] emergency fund.
However, if you only invest in investment funds then it gives a higher risk. You should also consider investing in opportunities like:
As explained in my previous article on buying the dip: The market is always more important than the strategy – we can’t always overcome this but we can always manage our risk better.
Final words – Things to consider
A lot of these examples here are US-based. European broker fees can sometimes be higher, and investing overseas can often be a pain.
There are US brokers that accept non-residents, for example, Schwab.
There are also occasions where you could be taxed twice on your profits or capital gains when investing abroad. Once in the country of the investment, and once in the country you reside in.
Just because the investment is diversified, it doesn’t mean it is risk-free. Stock markets as a whole can still crash.
In the event of a bear market, often an index fund is still safer than having individual company shares because companies can default and lose value in a crisis.
In this sense index funds are still preferable. But I don’t want to understate how volatile they can be. It may be advisable to invest in a more managed fund and pass on this difficult task in the time of a long recession.
💡 Read more about how to manage your investment portfolio
I hope you liked this blog post about investment funds.
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