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Saving: A Simple Low-Risk Investment Strategy

If the recent stock market turmoil has you in a panic, it might be time to think saving and index funds.

The Dow Jones Industrial Average's recent one-day drop of 777 points most likely sent more than a few people's hearts into a flutter, if not full-scale panic. Drops like that make people question why they invest in the stock market, and the reaction is usually to run to safer investments; but if you have your personal finances in order and are investing for the long term, such drops in the stock market itself aren't anything to overly worry about (what these plunges mean for the economy is a different story).

When it comes to investing, there is a low-risk, high-return investment strategy that's easy to learn and every family should adopt. Saving and putting your money to work in index funds isn't as sexy as picking a winning stock and it's probably not something that you'll be bragging about to your friends at end-of-the-year parties, but it will provide you with a nice retirement nest egg with little risk because the strategy has a lot more to do with issues that you can control than how the stock market is doing any particular month.

The first step is to realize that you should spend your free time where it will benefit you the most financially. That place is not learning the intricacies of how to pick individual stocks. When you realize that simply duplicating the S&P 500's performance through index funds will put you well ahead of what you could likely achieve on your own or what most fund managers will produce, you have placed yourself in a position to take advantage of the limited time you have to spend on investing.

The main area you should spend your time is learning to save money to build your investment funds. The average person gets ahead by learning how to budget, how to save money and how to be frugal, not by monitoring what the stock market does on a daily, monthly or even yearly basis. It's in your financial interest to spend your time figuring out ways to save money rather than trying to find ways to trade in and out of market volatility. It is far easier and rewarding to your bottom line to save money than to try and get a better return rate.

There are a number of reasons for this. The most important is that it is not a choice of either investing in the stock market or saving money. When you spend your time looking for ways to save money, you can then take this money and also invest it in an S&P 500 Index fund without it taking any additional time figuring out which stocks to bet on.

Index investing allows you to receive the benefit of compound interest while having a larger base of money to place into the investment. Even if you were a genius stock-picker, you would have to generate double-digit returns over the S&P 500 on a yearly basis to have a chance to compete with someone who learns how to wisely save money.

For example, let's take someone that earns $50,000 a year. If that person normally saves 10% a year and then spends five hours a week investing to achieve a return of 15%, the person would end up with an investment totaling $5,750 at the end of the year. This scenario would be a return that most people would be ecstatic with.

When you look at it from the perspective concentrating on saving and then taking that savings to invest, however, it means that the person would only need to save $750 for the entire year or a little under $65 a month over their normal spending to get the same return. It is actually even less since this isn't even taking into account the interest that would be earned in the S&P 500 index fund. Most people can squeeze much more than $100 a month in savings from their budget without even feeling any pain.

In addition, implementing a saving strategy is much easier than learning to pick stocks and provides quicker returns. Your savings are usually immediate and not realized over the entire year. Add in the benefits that there are no taxes levied on the money you save and no stock market fees to pay in order to get the savings and it becomes even more of an advantage to concentrate your time on learning to save money.

Once you realize that you're better off spending your time budgeting and living frugally rather than searching for a better investment return, then there is no reason to panic when events like last Monday's occur. If you spend your time learning how to save money while not disrupting your lifestyle, then even when the stock market is in turmoil, you can rest peacefully knowing that your savings will simply buy more index fund shares.