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Investing in Stocks vs Index Funds

Wednesday, June 26th, 2013
Posted in Advice by Joel Gross

My younger brother Josh and I had an interesting conversation about what the best forms of investment are and how he should use his time. This is what I had to share:

I have studied finance and stock with great intensity since I was 12, majored in finance in college, worked at Merrill Lynch (financial institution), and have invested my own money very successfully since graduation….. so things I take to be obvious are not obvious to others. I will try to be more patient and nice.

 I do not recommend you invest in stock options or put your money in a savings account. I specifically recommend you use an index fund or perhaps a mutual fund to invest your money (this IS buying actual stocks in the stock market, just through an intermediary, make sense?)
Let’s say that grandpa’s assertion is correct: he can beat the stock market consistently over time in just 1 hour per day (which is not true of even bigtime professional investors who spend 12 hours a day investing for decades). Look at these 2 examples:
  1. Investor Grandpa…
    1. Invests in stocks himself $1 million and earns 6% average year over year
    2. Spends 1-2 hours per day researching stocks, discussing, calls, investing and trading. 400 hours per year. 400 hours / 8 hours in business day = 50 FULL WORKING DAYS PER YEAR
    3. RESULTS: $1m * 6% = $60k investment increase
  2. Worker Grandpa
    1. Invests in mutual funds or index funds himself $1 million and earns 5% average year over year
    2. Spends 1-2 hours per day building a side business earning on average $40 per hour doing consulting (or airplane certification training or whatever).
    3. RESULTS: $1m * 5% = $50k investment increase + $40 per hour * 400 hours of side business work = $16,000. Total = $16k + $50k = $66k.
That is with the assumption that Grandpa earns a measly $40/ hour (most everyone I know with businesses can make significantly more). Now let’s look at your case which makes it even clearer:
  1. Investor Josh…
    1. Invests in stocks himself $25k and earns 6% average year over year
    2. Spends 1-2 hours per day researching stocks, discussing, calls, investing and trading. 400 hours per year. 400 hours / 8 hours in business day = 50 FULL WORKING DAYS PER YEAR
    3. RESULTS: $25k * 6% = $1.5k investment increase
  2. Worker Josh
    1. Invests in mutual funds himself $25k and earns 5% average year over year
    2. Spends 1-2 hours per day building a side business earning on average $75 per hour doing landscaping (which I did 2 years younger than you)
    3. RESULTS: $25k * 5% = $1.25k investment increase + $75 per hour * 400 hours of side business work = $30,000. Total = $30k + $1.25k = $31.25k.
The bottom line for you Josh is that you should clearly invest in mutual funds or index funds and use the time you save more productively. There is a 20x greater return for you to put your effort into other areas.
Additional notes:
My investment hierarchy:

  1. A business you run yourself and control that is established
  2. A business you run yourself and control that is new
  3. An index fund
  4. A mutual fund
  5. Investing in individual stocks yourself
  6. Loaning money at a significant interest rate to people you trust
  7. Stock options – I use this strategy for the huge rewards possible. Gambling blood in me leads me astray… but I have done well. Went from $60k to $90k in the last 3 three months.
  8. Bank savings
  9. Loaning money to people you don’t trust at significant interest rates or to people you do trust at low interest rates
  10. Poker at home
  11. Poker at a casino
  12. Blackjack at a casino
  13. Slot machines at a casino
  14. Lottery tickets
My point is that you should let a paid professional do your stock investing for you… put your money into an index or mutual fund. Make sense?