Last week, I talked about mutual funds and how they are able to grow your money much better than savings accounts. One of the problems with mutual funds is that there are so many to choose from. Personally, I just don’t have the time or desire to really hunker down and maul over financial details of funds, what they are invested in, and how much.
And that’s a real problem. When I didn’t know any better, simply being shown an impressive graph of a fund with a name like ‘Mackenzie Ivy Foreign Equity-A’ by a financial adviser with a reassuring smile was all I needed to invest.
It could well be that Mackenzie Ivy Foreign Equity-A is a great place to invest your money, but I personally don’t know. And I don’t really care either because I don’t have the time to research mutual funds, and quite frankly, I find it really boring.
As I mentioned in my first blog post, I have things I want to do with my one life. I have ambitions and passions to pursue, and the sooner I can stop having to work for the Man, the sooner I can really focus on doing the things I want to do. This means that my free time now is also valuable, too valuable to waste researching boring things.
Like many before me, I thought to myself, “Surely, someone has figured out the best place to put money, this must be a solved problem.”
After a short search, it was revealed to me that the Standard & Poor’s (S&P) 500 was such a place and that it was actually a well known solution amoungst investor types. Indeed, Even Warren Buffett, the most successful investor of the 20th century, where he amassed most of his staggering 72 billion dollar fortune, has very publicly endorsed the S&P 500 as the best place for the average person to put their money.
The S&P 500 itself isn’t a fund, it is an index: a list of 500 large companies publicly traded in America that basically make the world work. Companies are put on or taken off the list based on specific criteria by a committee.
In its current form, the S&P 500 has been around since 1957. The way the index is calculated is pretty simple: Add up the capitalization (number of company shares multiplied by the share price) of all 500 companies in the index, and divide by ‘the Divisor’. The Divisor is technically proprietary info owned by the people who manage the S&P 500, but it is approximately 8.9 billion.
The math behind the S&P 500 is basic: the sum of the capitalization of the companies in the S&P 500 index is something close to $18.8 trillion, divide that by 8.9 billion and you get 2108.10, the S&P 500 index as of March 20, 2015.
Because the index is based on the stock market share price of each of the 500 companies, the better individual companies do, the higher the S&P 500 index goes. Over the last 5 years, the S&P 500 index has gone up an average of nearly 16% per year. Over the last 20 years, 11% per year. Over the last 100 years, 12% per year. At 12%, you are doubling your money every 6 years, $100 with the S&P 500 could become $200 in 6 years.
Of course, it’s not quite that straight forward. The S&P 500 is not a fund, but and index. There are several funds, however, whose sole purpose is to emulate the index for as cheaply as possible. But there are still three largely unavoidable costs that will effect all investments: taxes, inflation, and fees. These costs will chip away at what you actually end up taking home on any investment.
But as far as investments that require the least amount of energy go, it’s hard to beat the S&P 500. There are all kinds of companies in that index that you use every day: Disney, Visa, Apple, Starbucks, Black & Decker. Other well known companies like Boeing, P&G, Gap, Staples, Ford, Whirlpool and Google are also included.
The S&P 500 is a very diverse investment. The individual companies that make up the index make your world go round: they mine natural resources, build all the stuff you use, move goods, grow food, make the internet useful, provide electricity, entertain you, cloth you, etc. It is a single investment in 500 companies that gives you a little part of every industry. And it is good to be diversified, because unseen things always happen. I sure wouldn’t want all my life savings tied up in only Starbucks if a mold that killed the worlds coffee crop broke out (god help us…).
Fees are another strength of the S&P 500. Because the index is easily calculated and publicly available, software can easily do the job of fund managers, significantly reducing fund fees. My preferred S&P 500 ETF (Exchange Traded Fund) is Vanguard’s, its management fee is only 0.08%.
So how does one put their money in the S&P 500? To answer that, we must first consider some new realities, namely, the incredible amounts of money one can make. Consider having $100k in the S&P 500, it is possible to double that in 6 years. That’s an average of more than $15k per year of investment income. Imagine having $10 million in the S&P 500?
The government is fully aware of the massive potential for income on investments, and has taxes in place to rain on a good investors parade.
Taxes are a problem well known by Canada’s wealthy, where solving the problem of having to amass a fortune becomes the problem of finding the best way to avoid taxes when withdrawing from said fortune. But for anyone who plans to someday live off interest from investments, knowing how to avoid taxes from the start is key.