You've probably heard time and time again that investing in the stock market is a great way to grow wealth over time. But investing in stocks also requires time, patience, and skill.
After all, you can't just randomly pick stocks out of a hat and hope for the best. Rather, you'll need to assemble a diverse mix of quality companies with solid growth potential. That's something that will require a lot of research.
Or, there's a simpler way to go about building a solid investment portfolio that will serve you well for the long haul. In fact, famed investor Warren Buffett thinks one specific investment type could be the average person's ticket to making a lot of money. Here's what it is.
Welcome to index funds
Many people who buy stocks do so on an individual basis. With index funds, you get to own a whole bunch of different stocks with a single purchase.
But what are index funds anyway? In short, they're passively managed funds that aim to match the performance of the market indexes they're associated with.
Some mutual funds are actively managed, which means they're run by actual people whose job is to assemble a rewarding mix of stocks. Index funds don't have that setup — they're based on existing indexes, not the decisions of specific people. But that's a good thing, because that actually keeps their investment fees down.
So how might an index fund work in practice? Say you buy shares of an S&P 500 index fund. That means you'll effectively get to own 500 different stocks. If the S&P 500 itself has a great year, the value of your portfolio will rise. It's that simple.
Now to be clear, there's a downside to buying index funds, and it's that you don't get a say in the companies you invest in. Also, index funds won't help you beat the market. An S&P 500 index fund, for example, won't seek to do better than the S&P 500 itself, but with the right investment mix, you may be able to do better.
But do you really want to take that risk? As an average investor, you may not have the skills to hand-pick stocks that will outperform the broad market. And that's OK. In fact, that's specifically why Warren Buffett thinks most investors can benefit from index funds.
Now that said, it's often the case that ultra-wealthy individuals like Buffett don't own index funds themselves. And there are a few reasons for that. First, the wealthy can afford to take on more risk in their portfolios, so they may opt to select individual stocks instead. The wealthy can also diversify outside of stocks by buying real estate and other assets that require access to cash.
Furthermore, Buffett himself is a seasoned investor with an impressive track record, so he's the type of person who doesn't need index funds because he has the knowledge to hand-pick companies to invest it. But if you don't have that knowledge, index funds are a great fallback option — one that could end up making you very wealthy over time.
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