Index Fund Investment

After the introduction to the ISA & SIPP accounts and their excellent TAX benefits, we also discussed the beauty of Compound Interest.

In today’s post, we are going to dig into an excellent strategy that can put your money to work for you, with a very limited time investment on your end. So if you are a busy person who can’t find the time to regularly review the financial markets, please keep reading this article, because you are going to love it!

What is an Index Fund Investment?

It is a portfolio of stocks or bonds designed to match or track the composition and performance of a financial market index. Therefore, Index funds seek to match the risk and return of a particular market based on the theory that, in the long run, the market itself will outperform any single investment. This means that an Index fund will follow what is called a passive investment strategy.

Index funds are an excellent option for beginners, because you can own a wide variety of stocks, with very good diversification, and lower risk. That’s why a lot of beginner investors purchase index funds to obtain a better investment rather than buying individual stocks.

Advantages

Index funds have lower expenses and fees than actively managed funds.

Strong long term performance, which make these funds ideal for passive long term investors.

Lower risks due to diversification.

They can be an excellent opportunity for Passive Income, as the individual investor doesn’t need to spend time looking at the financial markets.

Disadvantages

I honestly can’t find any disadvantages for Index funds. As always, this is only my personal opinion.

Why choose an Index Fund Investment?

Aside from the aforementioned advantages, I am going to share with you some data that had a tremendous impact on me when I first became aware of it: The stock market returns since 1900. Please hold tight.

If you invested $100 in the S&P 500 at the beginning of 1900, you would have about $8,899,299.50 by the end of 2022, with an important assumption: you reinvested all dividends. This is a return of investment of 9.75% per year.

Another important piece of information: This investment result beats inflation during this period of 122 years for an inflation adjusted return of 6.62% per year.

In other words, I choose to invest some of my savings in an Index Fund Investment because I can put my money to work, and I let the magic of the compound interest happen.

I also wanted to share with you my source of information for these impressive numbers. There are endless options of where to get economic indicators. However, I personally found the lack of clear resources on the impacts of inflation on economic indicators to be disappointing. However, there is an author who has done an amazing analysis about CPI and S&P500 over the years. His name is Ian Webster and you can find his work here.

I am really grateful that he shares all of this data for free!

“Inflation Calculator.” U.S. Official Inflation Data, Alioth Finance, 11 Jul. 2022, https://www.officialdata.org/

How do I invest in an Index Fund Investment?

Several years ago I started to invest in a couple of Index Fund Investments. However, we need to be very strict with our plan, and stick to it firmly, with no exception. Here are the main rules of this plan:

  • My goal since then has been to top-up my index fund in a monthly basis with the same amount of money. To help me with this, I’ve got an automatic direct debit in my account. So every month, £150 goes directly into my investment account. You can also allocate that money into your chosen Index Fund straight away so you ensure that the money is always invested and working for you.
  • HOLD, HOLD and HOLD! The second rule is to always hold your investment. It’s perfectly normal for the financial markets to go up and down. As we have discussed a few times, it is critical to have the correct mindset before you start looking into any kind of Passive Income. This one is not different. We need to be strong and keep to our strategy no matter what is happening in the world. The XX century was a very conflictive one, we had 2 world wars, the Wall Street Crash of 1929 and lots of other disasters. Despite them, as we have already seen, the S&P 500 has been able to beat the inflation rate by 6.25%.
  • The third and final point of this strategy is to select the correct Index Fund for you. There is no right or wrong answer here, however this can be quite a complex topic, so I will share with you my best advice and tips in a separate post. Stay tuned!

When should you start investing?

 ASAP! If you have read my post The Magic of Compound Interest, you can see the impact of adding £150 per month during 28 years: £310k ready to make your retirement easier. Imagine that instead of letting your money work for you during this period of time, you start when you are 25 years old, and you get the money when you retire, let’s say at the age of 67. In 42 years you could make over 1 million pounds! So my advice is to start investing in an Index Fund yesterday. You can find the breakdown of this crazy amount of money below. Please do not forget to read the rules of the scenario below in me previous post The Magic of Compound Interest.

Thanks a lot for reading, and please reach out to me if you have any questions!

Data policy – All information should be used for indicative purposes only. You should independently check data before making any investment decision. TheRealPassiveIncome.com cannot guarantee that the data is accurate or complete, and accepts no responsibility for how it may be used.

DISCLAIMER: Before I leave you today, I want to reassure you that  www.therealpassiveincome.com is only sharing my personal view of these products, based on my previous experience and knowledge. Therefore, as a kind reminder, please read the following statement of the T&C of this website:

“Therealpassiveincome.com is NOT regulated or authorised by the Financial Conduct Authority (FCA). For more information, please refer to the FCA website (https://www.fca.org.uk/).

All investing in the securities markets, cryptocurrencies, or any other asset involves risk. Therealpassiveincome.com is NOT providing any financial investment or TAX advice service. You must know that any decision to make any investment, regardless which kind of product, in the financial markets, is a personal decision that should only be made after thorough research, including a personal risk and financial assessment, and the engagement of professional assistance to the extent you believe it necessary. Therefore, We are not responsible for any action you undertake which results in financial or other kind of loss.”

The Magic of Compound Interest

Welcome to another post on  www.therealpassiveincome.com

The topic we are discussing today can be a real game changer for your personal finances, so please, hold on tight and get ready for some shocking information!

I am sure you know who Albert Einstein is. He was once quoted saying: “Compound Interest is the eighth wonder of the world. Who understands it, earns it; who doesn’t, pays it”. I assume that we can all agree that he was one of the greatest and most influential physicists of all time. So let’s take this quote seriously for a moment. I am going to put forth some solid arguments that will hopefully help you think a little more like our good friend Albert after reading this post.

Let’s begin with a basic definition that will be added to our Glossary. What is Compound Interest? It is simply when you add the earned interest for any financial product back into your principal balance, which then earns you even more interest, because you start compounding your returns. In other words, compound interest makes your wealth & money grow faster.

Now let’s add some examples to this definition. I’ll start off by describing two different scenarios:

Scenario 1

Initial capital invested: The first day of the year, we add some savings amounting to £1,000.

Recurrent Top-up: We make our own commitment to add a fixed amount to this pot every month. In this example it’s £150. And we imagine that this money is a recurrent Direct Debit. As an additional commitment, we increase this monthly top-up by 4% each year. So in the first year we add £1,800 to this account, the second year will be £1,872, and so on.

% of interest: This is the amount of interest we are going to get every year. (OR This is the amount of interest we will receive annually.). And this might be the real challenge. How do we ensure that we will  get an average of 8% return during the next 28 years? For this I am proposing two separate strategies, always using our most TAX efficient vehicles: ISA Account and SIPP Account:

  • Dividend strategy
  • Index Fund Investment

Bear with me, as the next posts will disclose a lot of crucial information about both of these strategies!

Interest reinvested: This column shows the amount of actual return we will obtain every year, based on our 8% objective.

Final Balance: This is the final expected amount that we will have in our ISA or SIPP account at the end of every year.

Please find below a table that summarizes all of the above explanations in this first scenario:

I know there are a lot of numbers on this table, so let’s focus on a few conclusions:

  • The total amount invested over the years amounts to £95,339.32 + £1,000 as initial capital invested.
  • This scenario shows that if we are able to obtain a 8% return per year, we will have generated over the years an amount of £214,231.06.
  • If we are able to follow all of these assumptions through the years, we could have a lump sum of £310,570.37, which is a lot of money in my opinion!

Scenario 2

I don’t want to make things more complicated so the only difference between this scenario and the previous one, is that in here we are going to cash out the 8% return every year. Let’s take a look at  the picture below to see the impact of this change:

As shown on the chart above, we get as a final balance our capital invested over the years: £95,339.32 + £1,000 (initial balance). During this time, we have cashed out the return obtained at the end of each year. Obviously, we have had some cash available to use, but there is a huge disadvantage in this second scenario: as we are not compounding the 8% interest obtained every year, we have made “only” £96,225.78 over the same amount of time.

This means we have a final lump sum amounting to £96,225.78 + £96,339.32 = £192,565.09.

Conclusion

If we compare both scenarios, we can clearly appreciate the magic of the one with Compound Interest, can’t we?

If our choice is to compound our yearly return, we get a final lump sum amounting to £310,570.37 versus a final amount in Scenario 2 (withdraw return every year) of £192,565.09.

This chart shows us a variance between both scenarios amounting to £310,570.37 – £192,565.09 = £118,005.28.

As with everything in finance, there is not a single correct answer, and over the years we all might need some extra cash at some point. However, if we are disciplined enough to keep going with our plan, we can put our money to work for us! We will be able to enjoy a good retirement, where hopefully money won’t be a problem, and more importantly, WE won’t be a financial burden for our grown-up children.

Thanks a lot for reading, and please reach out to me if you have any questions, as understanding this post can be a real game changer for our future financial situation!

Data policy – All information should be used for indicative purposes only. You should independently check data before making any investment decision. TheRealPassiveIncome.com cannot guarantee that the data is accurate or complete, and accepts no responsibility for how it may be used.

DISCLAIMER: Before I leave you today, I want to reassure that www.therealpassiveincome.com is only sharing my personal view of these products, based on my previous experience and knowledge. Therefore, as a kind reminder, please read the following statement of the T&C of this website:

“Therealpassiveincome.com is NOT regulated or authorised by the Financial Conduct Authority (FCA). For more information, please refer to the FCA website (https://www.fca.org.uk/).

All investing in the securities markets, cryptocurrencies, or any other asset involves risk. Therealpassiveincome.com is NOT providing any financial investment or TAX advice service. You must know that any decision to make any investment, regardless which kind of product, in the financial markets, is a personal decision that should only be made after thorough research, including a personal risk and financial assessment, and the engagement of professional assistance to the extent you believe it necessary. Therefore, We are not responsible for any action you undertake which results in financial or other kind of loss.”

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