The Simple Path to Wealth with Index Fund Investing

Investing in index funds is a straightforward way to build wealth over time.

By investing in a total stock market index fund, you can gain exposure to the entire US stock market, which has historically provided a higher return than other asset classes.

Index fund investing is a low-maintenance approach that requires minimal effort and research.

With a total stock market index fund, you'll own a small piece of every publicly traded company in the US, which can help you ride out market fluctuations and avoid costly mistakes.

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The Simple Path to Wealth recommends keeping your investing strategy simple, and it's a strategy that has proven to be more profitable. Simple is good, and simple is easier.

Index funds outperform actively managed funds because they have lower fees. The fees for actively managed funds are notably higher, which can eat into your returns. Collins recommends using index funds like VTSAX (Vanguard Total Stock Market Index Fund) for stocks, which provide the best returns over time and serve as an inflation hedge.

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The 3 Tools To Wealth recommended by Collins are Stocks, Bonds, and Cash. Stocks are the core wealth-building tool, and Bonds provide income and smooth out the rough ride of stocks. Cash is good for covering routine expenses and unforeseen emergencies.

Here's a breakdown of the recommended asset allocation:

Asset allocation is a crucial aspect of any investment strategy. It's essentially dividing your investments among different asset classes to minimize risk and maximize returns.

The JL Collins Simple Path to Wealth Portfolio recommends a 75% allocation to stocks and 25% to bonds. This is a simple and effective way to build wealth over time.

Index funds offer a great way to construct a diversified portfolio and achieve robust long-term returns. By tracking specific market indices, such as the S&P 500 or a total stock market index, you can gain immediate ownership of a diverse basket of hundreds or thousands of stocks.

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The diversification resulting from investments in index funds helps mitigate market fluctuations. With no single company or sector exerting a significant impact on your investment portfolio, this approach provides stability in contrast to concentrated holdings.

Here's a breakdown of the recommended ETFs for the JL Collins Simple Path to Wealth Portfolio:

Understanding correlation is also essential in asset allocation. Correlation measures the degree to which the returns of two assets move in relation to each other. A correlation of +1 indicates perfect positive correlation, while a correlation of -1 indicates perfect inverse correlation.

We've discussed the Health Savings Account (HSA) in the past and why it's known for having a triple tax advantage.

An HSA is a tax-advantaged savings account for medical expenses, like an IRA, but specifically for medical bills. As of 2020, you can set aside up to $3,550 for an individual and $7,100 for a family each year.

For another approach, see: Wealthfront Tax Loss Harvesting

If you're 55 or older, you can add another $1,000 to each of those amounts. Contributions to an HSA are tax-deductible, making it a great option for funding medical expenses.

You can withdraw money from your HSA tax and penalty-free anytime to cover medical expenses, as long as you save your receipts. Even years later, you can use the money for medical bills.

Once you reach the age of 65, you can withdraw your HSA for any purpose penalty-free, although you'll owe taxes on the withdrawal unless it's for medical expenses.

On a similar theme: Day Trader Tax Deductions

Stocks provide the best returns over time and serve as our inflation hedge, making them a great core wealth-building tool.

Collins recommends investing in VTSAX (Vanguard Total Stock Market Index Fund) for stocks.

Bonds provide income, tend to smooth out the rough ride of stocks, and serve as our deflation hedge, making them a great addition to a diversified portfolio.

VBLTX (Vanguard Total Bond Market Index Fund) is a great option for bonds.

Cash is good to cover routine expenses and for any unforeseen emergencies, and it's essential to keep an emergency fund.

You can keep the majority of your cash in VMMXX (Vanguard Prime Money Market Fund) and have separate accounts for emergencies, travel, and investing in passive real estate.

Index funds offer extensive market exposure, diversification, and stability, making them an excellent means to construct a diversified portfolio.

Low-cost index funds have lower expense ratios than actively managed funds, allowing you to retain a greater portion of your investment returns.

Reduced fees can accumulate into a substantial sum in the future, exerting a significant influence on your long-term wealth.

Making your first deposit is a crucial step in building wealth. It's a small step, but it's a start.

Automating your finances can make it easier to save and invest by regularly transferring predetermined amounts from your checking account to your specified goals.

In fact, automating your finances is like putting your wealth-building on cruise control, seamlessly steering you toward a more prosperous future.

A consistent deposit of even a small amount can harness the power of compounding, where your returns generate additional returns over time, creating a snowball effect that progressively expands your wealth exponentially.

Opening an investment account and depositing your first $10 can seem insignificant, but it's a start, and it's something to be celebrated.

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Index fund investing is a straightforward approach to building wealth. It's all about keeping things simple, as recommended by the Simple Path to Wealth.

Index funds offer extensive market exposure by tracking specific market indices, such as the S&P 500 or a total stock market index. This means immediate ownership of a diverse basket containing hundreds or even thousands of stocks, effectively spreading risk across various companies, sectors, and industries.

The diversification resulting from investments in index funds helps mitigate market fluctuations. With no single company or sector exerting a significant impact on your investment portfolio, this approach provides stability in contrast to concentrated holdings.

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Index funds passively follow indexes, minimizing management expenses. With expense ratios much lower than those of actively managed funds, they incur significantly fewer charges, allowing you to retain a greater portion of your investment returns.

A low expense ratio is key to long-term wealth. The Simple Path to Wealth Portfolio has an expense ratio of 0.03%, which is considered low compared to other funds.

Here's a comparison of the expense ratios of some popular index funds:

By investing in index funds, you can harness the power of compounding, where your returns generate additional returns over time. It's akin to a snowball effect, progressively expanding your wealth exponentially.

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Dividend yield is a crucial factor to consider when evaluating investment options. A dividend yield of 1.85% was provided by the Simple Path to Wealth Portfolio over the last twelve months.

The portfolio's dividend yield has fluctuated over the years, ranging from 1.40% in 2021 to 2.23% in 2019. A dividend yield of 1.87% was achieved in 2024, which is slightly higher than the 2023 yield of 1.85%.

The portfolio's components, such as the VTIVanguard Total Stock Market ETF and BNDVanguard Total Bond Market ETF, also contribute to the overall dividend yield. The VTIVanguard Total Stock Market ETF has a dividend yield ranging from 1.21% in 2021 to 2.04% in 2019.

Rolling Returns offer a more accurate representation of an investment's historical performance by calculating returns over a set period of time, with the starting date rolling forward.

This approach helps investors evaluate the investment's consistency over time, making it easier to understand its potential for long-term growth.

A rolling return can be calculated for any period, but it's often used for 1-year, 3-year, 5-year, or 10-year periods.

To give you an idea of how rolling returns work, let's take a look at the 10-year rolling returns for the Simple Path to Wealth Portfolio, which have averaged around 11.12% since its inception in 2007.

Here's a breakdown of the 10-year rolling returns for the Simple Path to Wealth Portfolio and the S&P 500 index:

These numbers show that the Simple Path to Wealth Portfolio has generally kept pace with the S&P 500 index over the long term, with a slight edge in the 10-year rolling returns.

By looking at rolling returns, you can get a better sense of an investment's potential for long-term growth and its consistency over time.

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The more complex an investment is, the less likely it is to be profitable, according to Collins. This means that actively managed funds, which require expensive active managers, tend to have higher fees and lower returns.

Index funds, on the other hand, are often more profitable because they have lower fees. Collins recommends using index funds, such as VTSAX for stocks, to build wealth over time.

By keeping your investments simple, you can reduce your risk and increase your chances of long-term success.

Having a solid understanding of how much you can withdraw in retirement is crucial for a smooth transition. Collins recommends a 75% stocks / 25% bonds asset mix by retirement.

This asset mix is designed to provide a balance between growth and stability. By doing so, you'll have a more predictable income stream in retirement.

Withdrawing between 3-4% a year from your retirement portfolio is a recommended strategy. This rate allows for a sustainable income stream without depleting your assets too quickly.

By following these guidelines, you'll have almost a 100% chance of dying with more money than you started with.

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The worst drawdowns in the Simple Path to Wealth Portfolio are a crucial aspect of understanding its risk profile. A maximum drawdown is a measure of risk, indicating the largest reduction in portfolio value due to a series of losing trades.

The largest drawdown in the portfolio's history was 40.43%, which occurred on Mar 9, 2009. This was a tough time for many investors.

Recovery from this drawdown took a significant 480 trading sessions, with the portfolio finally recovering on Feb 1, 2011. That's a long time to wait for a rebound.

Here's a breakdown of the worst drawdowns in the portfolio:

The current Simple Path to Wealth Portfolio drawdown is 1.78%, a relatively small percentage compared to the worst drawdowns.