What is Index Investing? A Beginner’s Guide

If you are a new investor and on a journey to financial freedom, you may have come across the concept of Index Investing.

But what is it exactly? How does it work? How is it different from mutual funds? And why is it such a good vehicle for all of us that want to retire early?

In this article

1. What is Index Investing?
2. How Index Funds Work
3. Why Are Index Funds So Popular?
4. Index Fund vs Mutual Fund
5. Frequently Asked Questions

What is Index Investing?

For those who just want a dry 1-sentence answer, here it is:

Index investing means that you purchase a portfolio of stocks that meet specific criteria, such as the size of the company (also known as market cap.)

Now, for those of you who want to go deeper into the topic, read on. Let's unpack what ‘portfolio' means in that 1-sentence answer:

What is a portfolio of stocks?

Portfolio is a fancy word for ‘collection.' Typically, we use the word portfolio to talk about a collection of assets which may include stocks, bonds, real estate, art, and other assets. In other words, a portfolio is a collection of investments.

Index investing shares that same definition. It is a collection of different investments.

However, it differs from a traditional portfolio in its composition. In a traditional portfolio, the assets are chosen specifically due to their characteristics and diversity. For example, you may want to own shares from several different industries, or from different companies.

In an index fund or portfolio, you do not select individual assets. Instead, the fund or portfolio invests all of the money in market indices, like an S&P 500.

Index funds can be broadly classified into two categories: passive and active.

Passive index funds track an underlying index that captures the features of many asset classes as well as other market influences. They are less volatile than actively managed funds, because the underlying index can easily be rebalanced in order to reduce risk.

Actively managed index funds, or mutual funds, on the other hand try to outperform the index.

We'll get back to the difference between passive and actively managed funds later.

How Index Funds Work

Index funds are funds that track a specific index. For example, VOO is a Vanguard Index Fund that tracks the S&P 500 index.

When you buy into VOO, your investment, your cash is then used to invest in all the companies that make up a particular index, in this case the S&P 500 index.

The companies that make up an index are selected based on their weights in the index.

Just like with actively managed mutual funds, the goal of an index fund is to make money off the gain in value of the underlying index.

While there's risk with every investment, index funds have an advantage that actively managed funds don't – they allow individuals to get a broad exposure to a segment of the stock market without having to go through the hassle of researching individual stocks. This is one of the reasons why index funds are so popular, especially in the financial freedom and early retirement community.

Why Are Index Funds So Popular?

The life of a stock market analyst, or that of a retail day trader can be a very stressful one.

I'm convinced that a lot of people can learn the skill of researching stocks, opening and closing multiple positions ‘at the right time'.

But…

There's a certain weight, a certain pressure that you invite into your life if you choose this route.

Not only financially, but also emotionally, mentally, which can lead to physical stresses and duress.

Most of us who are on the road to early retirement can't handle all that day-in, day-out, 24/7. And that's more than okay.

You also want to keep enjoying your life leading up to your (hopefully early) retirement, and not give your brain any reasons for panic attacks.

Mitigating Risk

Did you that 95% of day traders end up losing money? At least according to The Motley Fool's article “Is Day Trading Worth It?”.

So there's a clear, inherent, and significant risk to picking individual stocks. But, after having said all that, investing into the market is still the best suited vehicle to drive you towards your destination of early retirement.

Which type of investment vehicle can severely mitigate your risk?

This is where index funds come in. Essentially, instead of having to decide for yourself in which companies to invest your next $100 in, you can choose an index fund that does all of it for you.

Different index funds have their own criteria, such as industry, region, and market cap. I even compared the S&P 500 vs the Total US Market vs the Total Global Market over here.

This is why index funds are so popular, especially in our financial freedom and early retirement community. Because all of the guesswork, all of the legwork, is done for you.

The only thing you need to do is keep investing regularly.

And remember that…

Early Retirement is Easy

As I've said before on this blog, the road to early retirement can be simple (simple ≠ easy!), but we like to overcomplicate things.

We're looking for the shortcuts, the hacks, the tricks, the “hidden secrets ‘they' don't want you to know about”.

But, essentially, it comes down to these simple steps:

1. Spend less
2. Earn more
3. Save/Invest the rest

I've talked about this before on the blog, but the longest part on your path to early retirement is also the most boring one.

It's adhering to your investment strategy and…wait. There's nothing flashy about that. There are no shortcuts, secrets, or hacks to make time go faster.

Index Fund vs Mutual Fund

So, we now know that picking stocks individually is a near sure-fire way to more financial, emotional, mental, and physical stress and duress and that funds are the best way to go for the overwhelming majority of people (myself included, we just don't have the stomach to be in the stock market trenches on the daily – and that's okay).

You may have also heard about Mutual Funds.

Mutual funds are a type of investment vehicle that pools together money from many investors to make a “basket” of stocks. Mutual funds are managed by professionals who will research and pick the stocks within the fund.

Mutual funds can be considered as active investing (just not by you), whereas index funds can be seen as a form of passive investing.

Mutual funds can invest in stocks, bonds, and specialty funds like hedge funds. Essentially, the portfolio managers are the stock pickers of the fund and take their gathered information and analyses into account when making their investment decisions.

Where index funds track a ‘basket' of companies, mutual funds and their portfolio managers try to outperform the market.

There are 2 big reasons why I would advise against deferring your investing to a portfolio manager, like a mutual fund.

1. They Rarely Outperform Index Funds Long-Term

The good thing about the financial markets is that we have decades and decades of historical data.

Allow me to quote from Investopedia's article “The Lowdown on Index Funds”

Generally, when you look at mutual fund performance over the long run, you can see a trend of actively-managed funds underperforming the S&P 500 index. A common statistic is that the S&P 500 outperforms 80% of mutual funds. While this statistic is true in some years, it's not always the case.

A better comparison is provided by Burton Malkiel, the man who popularized efficient market theory in A Random Walk Down Wall Street. The 1999 edition of his book begins by comparing a $10,000 investment in the S&P 500 index fund to the same amount in the average actively-managed mutual fund. From the start of 1969 through June 30, 1998, the index investor was ahead by almost $140,000: her original $10,000 increased 31-times to $311,000, while the active-fund investor ended up with only $171,950.

It's true that over the short term, some mutual funds will outperform the market by significant margins – but over the long term, active investment tends to underperform passive indexing, especially after taking account of fees and taxes.

2. Their Fees Eat Up More Than You Think

The portfolio managers need to get paid somehow. They do this by charging fees on your total portfolio.

Their percentage fee is sounds low, with the average being between 1.4%-2%. And on a new, beginner investment portfolio that's objectively not a lot ($14-$20 in fees on a portfolio of $1000).

But, investing is a long-term game.

As your investment portfolio grows through your monthly contributions, compound interest, and the natural behavior of the market going up, so does their cut.

In the end, this could mean more than a 6-figure difference in your investment portfolio, as is shown in the image below.

Index funds on the other hand have lower fees, or expense ratios, due to their nature of being passively managed. For example, VOO has an expense ratio of 0.03%.

Want to get a crash course on Index Investing? My friend Jeremy from @personalfinanceflub has a video course on exactly this.

Frequently Asked Questions

Can an index fund investor lose everything?

Technically, yes. Because technically the entire market can go to 0. But, because index funds track specific companies based on region, industry, and market cap, an index fund going to 0 would mean that the entire stock market went to 0…and then we have other, more important things, to worry about than our investment portfolios.

Is now a good time to buy index funds?

You've heard the saying. The best time to plant a tree was 10 years ago, the second best time is now. The same goes for buying index funds. Still not convinced that you should go with index funds or stocks?

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How Major Global Events Impact Your Journey to Early Retirement

I'm writing this late February 2022, 1 day after Russian president Putin has ordered his military troops to attack Ukraine from different sides.

No worries, I won't get political.

2 years ago, the world was attacked – literally – virally, by SARS-CoV-2, its different variants, and what is now known as the Covid-19 pandemic.

Both of these have had an impact on the economy, on the market, and thus, on your early retirement. In some way. 2022 will also be known for a year of globally high inflation rates.

Whereas the S&P500 recorded astronomical gains during the pandemic, it's decreasing in value YTD (year-to-date).

So, let's talk about this. How do world events that impact the stock market impact your early retirement plans?

PS: I'm not an economist, financial planner/analyst, or anything like that. There's a full disclaimer at the end of this post, but suffice to say that I'm just a “regular guy”. A lot of other people go more in-depth on sequencing of return risk, which will also be linked throughout and at the end of this post.

In this article

1. What is Sequencing of Return Risk?
2. How Time Impacts Sequence Risk
3. What Can You Do Against Sequencing of Return Risk?
4. Risk Mitigation of Sequencing of Return Risk
5. When Should You Care about Sequencing of Return Risk?
6. Additional Resources

What is Sequencing of Return Risk?

The concept of sequencing of return risk (I'll use sequence risk from now on) is the risk that an investor will experience negative portfolio returns late in their working career and/or early in retirement.

This is heavily influenced by when (or the time that) an individual like yourself may start to make withdrawals from your investment portfolio, which will most likely consist of stocks and bonds.

For example, someone who started withdrawing from their investment portfolio on January 2022 may be kicking themselves in the head now – or, possibly, will soon – because their investment portfolio is now decreased (1) by the made withdrawal, and (2) the decrease of the overall market value.

S&P 500 Total Returns (1990 – 2009)

I'm going to use illustrations from this YouTube explainer video on “What is Sequence of Return Risk?'.

This scenario is looking at the returns, both actual and on average, of the S&P 500 without making any withdrawals from 1990 – 2009.

Starting value: $1,000,000 Ending value: $4,842,414 Total Returns: $3,842,414

Nice returns, right?

We don't see sequence risk doing its thing yet in this example.

This scenario is also looking at the actual and average returns of the S&P 500, during the same timeframe (1990 – 2009) but with making annual withdrawals of $50,000.

Starting value: $1,000,000 Ending value: $2,797,350 Total Returns: $1,797,350

Still nice returns, right? But it's already a difference of 53.22% compared to the previous scenario.

In this example, we do already see sequence risk at play. It just happens that, in this case, it works out positively.

How Time Impacts Sequence Risk

Remember, that sequence risk is the risk of experiencing negative portfolio returns during someone's early retirement. In other words, running out of money. We don't want that, right?

And remember that this risk is heavily dependent on time, or when you make withdrawals. In a bear, or a bull market. Those can in turn be influenced by global events, like the pandemic, or what's currently going on between Russia and Ukraine.

In the example above (1990 – 2009), the first few years everything was going smoothly. The market, as it does on average, went up.

Then, the dotcom bubble started growing and we can see that from 1996 – 1999 the market abnormally grew in value.

The bubble eventually burst in 1999 and you can see some abnormal declines from 2000 – 2002.

But… that $1,000,000 had already grown at such a rate that it benefited both from the average returns of the market, as well as the significant growth of market value before the dotcom bubble burst that it, essentially, could take the losses in the years that followed – including the global financial crisis of 2008.

If you look at the returns of the S&P 500 (displayed here in the video, you can see that, aside from the -3.10% in 1990, each year saw some good growth.

Until the bubble burst.

In the next example, we'll be looking at the S&P 500 but from 2000 – 2019. Same length of time, but very different results. You'll see why.

S&P 500 Total Returns (2000 – 2019)

This scenario is looking at the returns, both actual and on average, of the S&P 500 without making any withdrawals from 2000 – 2019.

Starting value: $1,000,000 Ending value: $3,241,326 Total Returns: $2,241,326

Again, some nice returns. But this doesn't show sequence risk. What if you started withdrawing $50,000 annually off of this portfolio during this timeframe?

This scenario is also looking at the actual and average returns of the S&P 500, during the same timeframe (2000 – 2019) but with making annual withdrawals of $50,000.

Starting value: $1,000,000 Ending value: $271,317 Total Returns: –$728,683

Ouch. Right?

Suffice to say that your investment portfolio wouldn't be able to take this hit, and that you will probably run out of money during your (early) retirement.

Why is this?

Whereas in the previous example of sequence risk (making withdrawals during 1990 – 2009) where the significant decreases of the market happened later on in those 19 years, in this example, they happened very early on.

Kind of like kicking the portfolio when it's already down.

What Can You Do Against Sequencing of Return Risk?

There is no sure-fire way to completely eliminate sequence risk of your investment portfolio, if it contains stocks and bonds.

Run far away from anybody who tells you otherwise.

Because, to be absolutely sure that you're not putting your portfolio at risk, you'd need to know what the market is going to do.

And nobody can predict the market.

Risk Mitigation of Sequencing of Return Risk

While there's no way to reduce the risk completely to 0%, there are ways that you can get closer to it.

Cash Is King?

In this case, it absolutely can be. Having a liquid asset, such as cash, available to you when major global events that are completely out of your control are happening can be a way for you to not withdraw for a year, or withdraw significantly less.

This brings me to my second point.

Be Flexible with Your Savings Withdrawal Rate

I've mentioned the Rule of 4% before on this blog. It's a general guideline a lot of us use to calculate your financial freedom number and has a big influence on what your eventual FI number will be.

But, do not use it as a strict rule! Especially when trying to simply mitigate your sequence risk. Maybe you can withdraw less in a given year, and bridge the rest with cash on hand.

Asset Allocation

When explaining what kinds of investment portfolios are at risk of sequence risk, I tried to keep the nuance intact of adding “an investment portfolio of stocks and bonds.”

Because your investment portfolio can also include other assets, such as commodities, or real estate. Some won't be (as directly) influenced by major global events, but can still either provide you with another income source during your retirement, or be something you can sell.

Now that I've mentioned income sources…

Multiple Streams of Income

If your livelihood is entirely dependent on your investment portfolio of stocks and bonds, it's like bringing a knife to a gun fight when it comes to your sequence risk.

That's why you need additional streams of income.

This can be pension checks, CD contracts, or simple businesses that you have some ownership in and pay out nice profits to you.

Your additional revenue stream doesn't need to be this 6- or 7-figure income generator. It can be something that brings in a nice extra $60,000 annually.

This can even help you eventually withdraw less from your investment portfolio.

Your business is also an asset that you can eventually sell for a multiple.

In fact, I'm such a big disciple of multiple streams of revenue that I also write about it on this blog.

Additionally, if you're still in your accumulating phase of early retirement (building your investment portfolio), having a few consistent streams of income can also be the reason why you'd need to withdraw only, for example, $30,000 from your investment portfolio, because you know the other $30,000 is coming from these other streams.

This can severely cut down the time it'll take you to reach financial freedom. A good business model to consider is affiliate marketing.

When Should You Care about Sequencing of Return Risk?

If you're in the accumulating phase of your early retirement journey aka building your investment portfolio and you know early retirement is at least 7 – 8 years away…no.

Don't change any of your strategies, objectives, or goals.

In fact, this may be a great time for you to invest the same amount you have been on a monthly basis but pick up more shares. From a pure stock market perspective AND you're in that accumulating phase, “everything is on sale”.

How are you handling major global events and the impact they have on the market? Are you changing anything in terms of strategy or objectives?

Additional Resources

Jack Bogle deserves his own embed:

What is Sequence of Return Risk?
Investing 101 – Sequence of Return Risk Explained
What is Sequence Risk? (Explained) | 4 Ways to Manage Sequence of Returns Risk in Retirement

Disclaimer:  I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only.

This post may contain affiliate links, which means that I may receive a commission if you make a purchase using one of these links, such as from the Amazon Associates program.

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S&P 500 vs Total US Market vs Total Global Market

The S&P 500 is a popular stock market index both for retail investors in the United States and globally. This article will compare the S&P 500 vs Total US Market and the Total Global Market.

What is The S&P 500?

The Standard & Poor's 500 Index is an index that tracks the leading 500 companies in the United States.

This is primarily weighted according to market capitalization, but because they also have other criteria, it's not an exact list of the top 500 companies with the biggest market cap.

In this article

1. What is The S&P 500?
2. Why Should You Consider Other Indexes?
3. The Total US Market
4. The Total Global Market
5. Which One Is Best?

Why Is It So Popular?

If you've been looking into financial freedom for a while, you've probably already come across the S&P 500 and…it's just everywhere.

Retail investors like us are talking about it, and people like Warren Buffet are talking about it and even making $1 million dollar bets.

A reason for this is that the S&P500 is one of the oldest index funds around, so there's a lot of actual historical data that people can analyze over.

(The Vanguard 500 Index Fund (with ticker VFINX) was founded in August 1976.)

And, what do you know, since its inception, this index has done really well.

Industry Weightings

One of the S&P 500's primary weighting of including or not including a public company in the index is market capitalization.

But if they were to go just for largest market caps, their holdings would look very different from how they're looking right now.

What this index also makes sure of is that it doesn't only include companies in the same industries.

The breakdown of sectors in the S&P 500 is as follows:

• Information technology: 27.9%
• Health care: 13%
• Consumer discretionary: 12.8%
• Financials: 11.4%
• Communication services: 10.8%
• Industrials: 8%
• Consumer staples: 5.6%
• Energy: 2.9%
• Real estate: 2.6%
• Materials: 2.5%
• Utilities: 2.4%

As you can see, the S&P is heavily weighted toward tech, health care, and consumer discretionary stocks. Meanwhile, there aren't as many utilities, real estate companies, or firms involved in producing and selling raw materials.

For a lot of people, predominantly United States retail investors, this is enough to buy-and-hold for the long road on their journey to financial freedom.

And if that's you as well, that's perfectly fine.

Why Should You Consider Other Indexes?

While the S&P 500 may have been the end-all-be-all for retail investors like you and I for a very long time, there are plenty of other indexes that could fit your financial goals and risk tolerance.

For example, The Dow Jones Industrial Average (DJIA), for example, is a very valuable index. It tracks 30 large-cap, publicly-traded companies: 25 from the S&P 500 and 5 from the broader Dow Jones Transportation Average (DJIA+Dow Jones Utilities Average). The Dow was invented in 1896 and represents a broad measure of the US economy.

Let's get into global economics for a bit.

United States Superpower?

Undeniably, a lot of the United States' wealth, as well as the wealth opportunities for other countries because of that wealth, came from the Industrial Revolution.

The United States was obviously already on the map, but this really put them on the map.

This benefited the US financial markets greatly from the 1950s to the pre-pandemic times.

But now, other countries are starting to put themselves on the map as well. In a big way.

Democratization of information (you could tell me all the emperors during the Ming dynasty in 10 seconds) combined with nations like China fixing a lot of where previous governments had failed is now putting the United States as a superpower to the test.

Now, look, I'm not an economist by trade. I'm sure there are some things that are flawed in how I tried to translate it with my laymen's knowledge, but I hope the point is made. And, if you've been looking around, you're seeing this, too.

The Problem with the S&P 500

Of course, there's no problem with the S&P 500 by itself.

But by only buy-and-holding this index, you may be missing out on the vast improvements, economic and otherwise, other regions of the world are taking. And even other United States companies that aren't even close to being picked up in the S&P 500.

Remember those industry weightings? Energy only includes 2.9% of it. And we all know, or should know, that this is obviously going to be playing a bigger deal.

The opportunities are out there for brilliant minds to come up with (much needed) solutions to answer some pressing renewable energy questions we as a species are facing.

These will become companies. These will attract a lot of investment money. These will make money. And they already are.

As well as other industries, like Space Exploration (ARKX), Genomics (ARKG) and much more.

The Total US Market

If you're in the United States, instead of buy-and-holding an S&P 500 ETF (like a VOO), you could bode very well with a Total US Market fund, like a VTI.

In fact, because VTI is tracking all United States companies, all the companies inside of VOO are also covered in VTI!

Currently, about 82% of VOO is the S&P 500, but this is expected to change even more.

But, the proof is in the pudding right?

Here's a chart tracking the difference in performance between these 2 funds:

Although a bit more volatile, VTI is actually slightly performing better than VOO.

source: PortfolioVisualizer.com

You can read more about this over on this blog post “VOO vs VTI”.

The Total Global Market

The above 2 sections were about United States funds only. But, as I've said before, other countries are starting to make some major leaps in terms of innovation, which leads to more economic growth.

Just like VTI (Total US Stock Market) also comprises VOO (S&P 500), a global stock market fund (like a VT) will also capture the entire United States stock market.

Now, if there are any major developments going on in China, Germany, the United Kingdom, literally anywhere else than the US, you'll also reap those benefits with this Total Global Market fund.

The VT fund tracks all companies in developing (countries having more or less stable growth, like Germany, the Netherlands, Austria, United Kingdom) and emerging markets.(countries that are experiencing significant growth (India, Russia, China, and others).

Currently, in July 2021, VT is about 60% US and 40% international.

Which One Is Best?

If you're in the United States, you're probably set with a United States Three-Fund portfolio, that includes some domestic, some international, and bonds.

If you're a non-US investor, your Three-Fund portfolio is probably best to be allocated towards something like a VTI + a global bonds fund.

You're Not Signing a Contract

Whichever one you choose, keep in mind that, with most brokerages, you can always close your position (for example, sell all your positions in VOO) and open a new position (for example, reallocating that money by buying VTI shares).

It's just really important that you don't pull out and then go into an period of analyzing.

Time in the market will always beat timing the market.

Where are you located, and which funds do you hold?

Disclaimer:  I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only.

This post may contain affiliate links, which means that I may receive a commission if you make a purchase using one of these links, such as from the Amazon Associates program.

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What is Market Capitalization & Should You Even Care?

Getting started on your road to financial freedom, you may see the concept of market capitalization (market cap) floating around various place.

This post will be a simple explanation of the concept, just so you can scratch it off your “to read/to know” list and go back to doing the work and learning more about passive income, investing, or side hustles.

The market value of a company refers to how much its stock is worth. The value can change within minutes because of influences such as stock volatility. To obtain information on market cap values for your favorite stocks, you need to DYOR (do your own research).

In this article

1. Why is Market Capitalization?
2. How is Market Cap First Calculated?
3. How Does Market Cap Affect a Company?
4. So, what is market capitalization?
5. Should you even care about market cap?

Why is Market Capitalization?

+1 if you get the Avengers: Infinity War reference.

Market capitalization is important because companies with higher market cap values tend to have greater revenue-generating potential. That's why they're used in some investment choices.

This may also be important to you if you want to start living off of your monthly, quarterly, or annual dividends.

One way market caps affect investment decisions is through the price-to-earnings ratio.

The higher the ratio, the more the stock is valued. When a stock's market cap comes up against its earnings per share, the ratio helps investors understand the potential earnings for their share.

This is also known as dividend yield.

Companies are typically divided according to market capitalization: large-cap ($10 billion or more), mid-cap ($2 billion to $10 billion), and small-cap ($300 million to $2 billion).

How is Market Cap First Calculated?

Now that we know that market cap refers to shares of a company, how is it calculated for companies that don't have any shares issued yet?

Market cap is first calculated when a company goes public. This is also known as an IPO (Initial Public Offering).

What happens during an IPO? An IPO is an initial public offer of stock. A company sells shares of stock and, in return, receives funds from investors. The IPO helps the company issue more shares and, therefore, increase their market cap.

How is an IPO priced?

But how do these companies that go public get their 1st stock price (ie. the stock price on Day 1 of being public)?

The stock price is partially calculated by determining the total income that a company has earned over a specific period of time, usually a year. The more money that a company makes, the higher their stock price will be.

Other deciding factors of that IPO stock price are:

1. what is the demand for the product or service?
2. how has this company been growing privately?
3. how does this company foresee their growth once going public?
4. what industry is it in?

The Market Decides

But, actually, whatever that IPO price may be, eventually the market (institutional and retail investors) decide how much it's worth.

For example, Snap went public in 2017 at $17 per share and, after the initial hype, it started trading below their ‘IPO price' for a good amount of years (even falling below $5 per share at some points) only to recover strongly a few months into the pandemic.

How Does Market Cap Affect a Company?

A large-cap company (your Amazons, your Facebooks, …) are much more desirable to institutional and retail investors, which, in turn, leads to higher prices for the stock.

Whereas mid- or low-cap companies are less attractive to those same investors, which is reflected in lower prices for the stock.

Some volatility is normal and to be expected on a daily basis in a company's market cap.

However, very big changes (like Facebook in Q1 of 2022) can shave off a lot of a company's worth, which gets the financial journalists writing articles about it, leading to more investors selling their stock, leading to more decreases in that company's value.

A company's market cap is also a factor of how attractive it is to potential buyers of the company, should they want to sell.

So, what is market capitalization?

Okay, I know, I know, that was a lot of theory stuff. But, you wanted to know!

Now, simply, in a few paragraphs: what is market capitalization?

Market capitalization, or market cap, is the total outstanding value of a company's outstanding stock shares. Since companies are often listed on the New York Stock Exchange, the market cap of these companies is determined based on the price of their shares.

For example, if Snap has 1000 shares outstanding of $1000 each, their current market cap is $1,000,000 (1000 x 1000).

This also means that, if their share price goes up, their market cap increases. If Snap share price were to go up with 10%, their market cap would now be $1,100,000 (1000 outstanding shares x $1100 share price).

If you prefer a video explainer on market cap, you can watch one here: Richard Hopkins' does a really good explanation of them.

Should you even care about market cap?

Ah, the actual question, now that your curiosity has been stilled a bit. Should you even care about all, or any of this stuff?

If you're a day-trader in stocks or crypto, then yes, you probably should.

If you're one of those people who just can't not live that kind of life, the more power to you, and I hope this information was helpful for you.

But, assuming you're the 99.4% who isn't lusting after a life like that, this information really doesn't matter to you.

Remember that the road to financial freedom is simple (fyi: simple ≠ easy!).

Spend less. Make more. Invest the difference.

You already know that, as someone pursuing early retirement, you're better off investing in ETFs vs stocks

The ETFs, whether you're going with a Three-Fund Portfolio, a Simple Path to Wealth route, or the advice that my buddy Josh recommends, it'll be, at most, a handful of ETFs you'll be holding for multiple years. Maybe even decades.

The issuers of those exchange-traded funds do this market cap think work for you. It's not on your plate, and you shouldn't scoop it on there either.

Remember to live your life outside of the spreadsheet, as Ramit Sethi has said.

If you invest in ETFs, you want to consider long-term timeframes, so you don't need to worry about your retirement nest egg on a day by day basis. The effect this we'll have is that you're free to focus on other things, including your family, your work, or (gasp!) hobbies.

What do you think? Do I have a point?

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Should I Invest in Stocks or ETFs?

If you're just about to start on your investing journey – which is a key part on your road to financial freedom – you may be wondering whether it's best to invest in individual stocks or ETFs (Exchange-Traded Funds).

I'll be talking and comparing both here, but, with keeping 2 crucial things in mind. You'll see it once you'll see it, I promise.

In this article

1. What Is Investing?
2. What Is a Stock?
3. What is an ETF?
4. Differences in Volatility Between Individual Stocks and ETFs
5. Stocks or ETFs: Which is Better?
6. The Simple Path to Wealth
7. Start and Sit Back

What Is Investing?

I don't think I need to spend a lot of time explaining what investing is.

Any investment, ideally, is made with the hopes of getting something (more) in return.

This doesn't apply only to financial investments:

• Investing time in relationships with your loved ones hopefully increases the bond you have with them;
• Investing time in your education hopefully increases your chances at that dream job you've always wanted since you were a kid, and also increases your chances at an above-average salary;
• Investing your time into binge-watching Netflix hopefully provides a sense of escapism, wonder, and entertainment

But, since this is a blog about wealth and making money, let's put our blinders on and reign in our focus to financial investments only.

You invest your money with the hopes of it appreciating in value that you then pocket at some point in time.

Your money is able to grow through compound interest and the Rule of 72.

What Is a Stock?

A stock is an asset that is traded on financial markets, or exchanges, like a New York Stock Exchange, or a Nasdaq. Companies issue stock to raise money from investors. A company uses this money to fund its operations or to purchase other companies.

Once a company goes public (IPO), retail investors like you and me can buy shares. Most platforms also allow you to buy fractional shares of companies' stocks.

For example, at the time of writing Meta's stock price is $232.00.

This means that you can buy 1 full share of Meta at that price, 2 for $464, 3 for $696, and so on and so forth.

But, with fractional shares, you can also buy 25% of 1 share at $58. Or 10% at $23.2. This is a good thing because the barrier-to-entry on the stock market is significantly lower vs having to wait until you're able to pay 1 full share (also, the stock prices of any company change multiple times an hour).

Now, on to ETFs.

What is an ETF?

An ETF (short for Exchange-Traded Fund), is a type of index fund.

Essentially, an ETF is a basket of different stocks from different companies. And, just like stocks, ETFs are traded on exchanges.

These exchange-traded funds pool together money from investors (you and me) into shares from different companies.

So, an ETF, like the S&P 500 (ticker symbols VOO or VUSA) tracks around 500 of the largest (based on market capitalization) US companies. (like Apple, Amazon, Alphabet, Coca-Cola, Verizon, Salesforce, and … about 494 others).

Should a company in that list fall below the 501st largest US company, that company is then taken out of the index, and the company which was 501st will be included.

In that way, the list is always up-to-date.

Here's a current list of all companies in the S&P 500.

There are a lot of ETFs with different specializations:

• ICLN is an ETF that tracks the performance of global green energy companies
• VGT is an ETF that tracks US information technology companies
• VNQ tracks US REITs, which are companies that purchase office buildings, hotels, and other real property.

The (Dis)advantages of Investing in ETFs

A disadvantage of only investing in ETFs is that it's less volatile than holding individual stocks.

Well, I say disadvantage, but that really depends on your perception.

To me, and to a lot of people in the #FIRE community, it's actually a big advantage.

Differences in Volatility Between Individual Stocks and ETFs

There's way less volatility in ETFs, since a stock, individually, can lose half its worth in 24 hours, but, within an ETF, that loss is less because there are other companies who may have had a good day or year.

Let's take this Instagram post for example, from @personalfinanceclub. Let's also assume that I've invested $600.

In the case of individual stocks, I'd have invested $100 in each of those six companies.

• Google: $100 + 7% = $107
• Facebook/meta: $100 – 21% = $79
• Snap: $100 + 28% = $128
• PayPal: $100 – 23% = $77
• Amazon: $100 + 9% = $109
• Etsy: $100 – 9% = $91

Total portfolio: $591.

Whereas, if I took that $600 and invested it in an ETF, in this case VTI, it'd look like this:

VTI: $600 + 1.8% = $610.8

The point I'm trying to make is not necessarily that ETFs will always outperform holding individual stocks, since this is just a snapshot in time.

But notice those changes in percentages. Notice how different the volatility is with individual stocks compared to this ETF.

Stocks or ETFs: Which is Better?

Circling back to the main question of this article, which is better to invest in when you're a beginner?

The answer is simple, dry, black-and-white, and boring: none is better than the other.

The market returns, on average, 8% per year. So, that's stocks, ETFs, or both. 8% is 8%.

So this isn't enough to answer the question. What we also need to consider is…

The Simple Path to Wealth

As with anything you're thinking about of doing, there are two considerations you need to keep in mind.

1. What is the long-term goal? What's your why? And what's the most frictionless way of getting there?
2. How does it suit you?

Let's start with #1.

What is the long-term goal?

If you're on this blog, chances are that you're looking to retire early. And, hopefully, by now, you know that getting there is a long-term game that will probably take several years.

The road to financial freedom isn't flashy. Honestly, financial freedom, or at least the road to getting there, is boring.

1. It's calculating your financial freedom number
2. Track your expenses and cut down on what's unnecessary
3. Increase your income
4. Invest
5. Wait (how long depends on which type of financial freedom you're pursuing).
6. Retire early

But a ship sails best if it knows where it's going.

Whether it's a few years or multiple decades, there'll come a time when you've gone through steps 1 – 4 and then comes the long middle part that is step 5.

How does it suit you?

There's a case to be made for the concept of boredom, and how our current, at least Western, society isn't at all set up to allow for it. Everything needs to be a tweet, a quote, a vlog, a picture, a post. And all ideally with a clickbait-y headline or caption.

I truly believe this creates disturbing dopamine addictions in all of us. It's like we can't stay in a calm desert, but always have to kick up some sand.

As Ramit Sethi said in his book “I Will Teach You to be Rich”, don't live your life in the spreadsheets.

There's a time and place for them. And then there's also a required time and place to just live your life, and know that your roadmap to financial freedom is doing its thing.

When you're finally able to let go of all that, most of you will come to realize that you're not stock analysts, or born day-traders.

Some of you will be. And your personality actually matches with that kind of lifestyle: analyzing stocks, opening and closing positions multiple times a day. And more power to you.

Most of us, including myself, will hate the stress that comes with all of that. It's just not for us.

You need to take all of this into account when answering this question of if you should invest in stocks or ETFs.

1. You want to become financially independent
2. 99.4% (yes, that's made up) don't want to, or shouldn't, be in the stock market's weeds on a daily basis

Simple and Uncomplicated

Simple and uncomplicated are near-synonyms of ‘boring'.

They're also a synonym of what's going to be the best long-term (remember, multiple years – even decades) investment strategy for beginners who want to retire early.

So, what is it? What's the strategy? What's a good place to put your money?

2 great resources that helped me decide on this was JL Collins book “The Simple Path to Wealth”, as well as @financejosh‘s ebook on “The Easy Way to Invest”.

It's not in stocks. It's in ETFs.

In fact, it's in ETFs that capture big parts of the entire US and international markets.

JL Collins' advice is a 75% allocation in VTI (all US stocks) and a 25% allocation in BND (all US bonds).

Financejosh's advice mostly follows the principles of the Three-Fund Portfolio. This essentially covers the total US stock market, the total International stock market, and the total US bond market.

Allocation depends on your age, weighing more heavily towards the stock markets in your younger years, and, as you get older, weighing more heavily towards the bond market.

If you're in the United States, reading/listening to those 2 resources can be enough for you to decide which strategy you're most comfortable with and then start.

If you're outside of the United States, you'll need to do some digging on similar ETFs that essentially track the same, but are more interesting for you to invest in, based on your location.

For example, in Belgium, and wanting to capture the total international stock market, a good ETF is the VWCE. This may also be true for other countries in the European Union, but this is where you need to DYOR (do your own research).

Start and Sit Back

Whichever ETF(s) you eventually decide on: start. As soon as you can. And once you've started, sit back.

Go live your life. Let the market do what it does. Which is, on average, go up, and get you closer to your financial freedom.

Which ETFs do you have a position in?

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Washington's Wealth - Accessible Financial Freedom

A blog about achieving financial freedom through passive income, side hustles, affiliate 

marketing and more for those who don’t have a head start with a 6-figure salary. 

Learn More: https://washingtonswealth.com/

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