Investing in the stock market has proven to be one of the best ways to generate long-term wealth. But where should first-time investors start? There are literally thousands of potential investments to choose from, not all of which are suitable for everyone.
The good news is that you don't need to be a financial expert to turn your savings into an impressive nest egg over time. In fact, there's one simple investment that will allow you to best 85% of professional money managers with essentially zero knowledge necessary.
New investors must understand these three challenges
What percentage of professional money managers do you think are able to beat the market over a five-year period? You might be surprised that it's only about 15%. That means roughly 85% of actively managed funds -- the term used for investment funds that try to beat the market by buying and selling various stocks -- are actually unable to beat the market over the long term.
There are a few reasons for this strange reality. The first is that to managing an investment fund incurs significant costs. Typically, an entire research team, plus a whole host of support personnel, needs to be paid. Usually, an investment fund will charge what's called an expense ratio : a percentage of your assets that it will keep for itself every year to cover these costs. Expense ratios can range widely but those of actively managed funds often are about 1%. That means that to simply keep up with the market, these funds need to outperform the market by 1% every year to cover management fees. This creates a structural disadvantage for actively managed funds.
The second reason most professional money managers fail to beat the market over the long term is that, in any given year, a minority of stocks might be responsible for most of the market's growth. In some years, for instance, less than half of the stocks included in the S&P 500 index are able to beat the return of the S&P 500 index as a whole. So for every stock an expert manager adds to their portfolio, odds are that this stock will underperform the market -- yet another structural disadvantage.
The final reason it's tough for professional money managers to beat the market is that actively buying and selling stocks can rack up extra tax obligations. Simply holding the same investment for long periods of time, in comparison, generates a much smaller tax bill.
Want to beat the market and avoid these structural challenges? The investment below is for you.
Beat the experts with this simple investment
The answer to the question above is simple: purchase shares in the Vanguard S&P 500 ETF (NYSEMKT: VOO) . This exchange-traded fund (ETF) is an index fund that aims to replicate the performance of an underlying index -- in this case, the S&P 500 .
Index funds are a great choice because instead of beating the market, the performance simply tracks the market. No expensive investment teams are needed. The fund's portfolio simply buys and holds whichever stocks are in the index. This lowers fees dramatically. The Vanguard S&P 500 ETF, for instance, charges an expense ratio of just 0.03% per year. That means you get to keep 99.97% of your capital year to year. Because 85% of fund managers fail to beat the market over any five-year period, you can instantly join the top 15% of investors by buying this index fund and holding it for the long term. Not bad for an investment that requires no skill or experience!
Although owning individual stocks can be a rewarding journey, don't let a lack of experience deter you from seeking the potential financial rewards of investing in the market. If you want to instantly create a high-performing portfolio, purchase the Vanguard S&P 500 ETF.
Should you invest $1,000 in Vanguard S&P 500 ETF right now?
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Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy .
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