What to Do Instead of Investing in Index Funds

Hey everyone.

Two days ago, I wrote about how investing in index funds ("passive investing") is only something you should do if you're investing for extraordinarily long time frames (i.e. for retirement, which should be 30 to 35 years away). Although I encourage you to go back and read my previous post, I'll reiterate the basic thesis behind my last post. It's that although the S&P 500 (an index or group of stocks that is a gauge for how the stock market is doing as a whole) has a compound annual growth rate of approximately 9% for the past 87 years, returns on the S&P 500 or the broad stock market in general can vary wildly from year to year, as demonstrated by this chart. If you don't have an 87 year time horizon or even a 20 year time horizon for your money, but want to make it work for you so you can reach financial objectives that are 3, 4, or 5 years away - i.e. buying a home, taking a trip around the world, buying a new car - what can you do to reap the benefits of investing in the stock market?

Well, before I tell you specifically what steps you can take, I must remind you that investing successfully is hard work. And it will require your dedication to it. By dedication, I mean that you must be willing to spend at least an hour a day (or 7 hours a week) doing the things outlined below. Come on, you can dedicate at least 4 percent of your week to improving your financial future, right? You can? Great! So here are the steps you need to take:

1) Determine what type of investor you are (a growth investor or a value investor) and then determine your risk tolerance by taking the following questionnaire. Growth investing and value investing are not mutually exclusive, necessarily, but they can be at times.

2) Spend time checking out the websites of stock newsletter subscription services that have thriving investor communities such as Cabot, TheStreet, The Motley Fool, or Morningstar. All of the above-mentioned websites have customer service lines that can help you decide which subscription service is best for you. Use these human resources!

3) After you have decided upon a subscription service that fits your budget and investment style (both of these criterion are equally important), then that's the time to start evaluating the newsletter's picks. When stock newsletters make picks each month, the newsletters usually include a synopsis of the company's financials, industry, and growth prospects. If you are more familiar with an industry that a particular stock recommendation falls into, and you think the prospects for the industry are bright, that might be a company on which you seek out more information. I would also suggest that you act like you're back in college and email the newsletter's editors with any questions. This will accelerate your learning curve when it comes to stock market investing.

4) Once you have your particular stock for each month set, you should dollar cost average into this investment. This way, you will buy more shares of that particular stock when the stock price is lower, and less shares when the price is higher, thereby lowering your cost basis. 

Well, that was a mouthful and seems like enough for today. But come back tomorrow for a "two-fer" when I'll be discussing where to find good information on companies and what metrics to look for, along with the importance of becoming a minipreneur. Until then...

JP $