What Recent Graduates May Want to Know About Index Investing

Personal Finance

The caps and gowns have been delivered. The assembly halls and football fields across the country have been readied for the big day. College graduation is a huge accomplishment and something to be celebrated.

According to recent statistics, more than two million Americans will complete their bachelor’s degree this year. Some will continue their education in a graduate program, while others will enter the workforce. At that point, they will likely have the opportunity to allocate some portion of their earnings to an investment account (401k, Roth IRA, etc.).

The potential benefits of setting aside money early and often is demonstrable. Admittedly, it’s very difficult to consider “retirement” when starting your first job. There are countless uncertainties, but that’s the way the world works. Uncertainty is endemic to the human condition.

One way to potentially minimize future concerns is to start saving and investing early. The concept of compounding returns can (and should) be understood whether you pursued finance courses or not. The combination of a significant time frame and indexed investing, while not bulletproof, will likely pay off down the road.

Average vs. Compound Rates of Return

A “compounded return” is the rate earned over a longer time horizon. This approach incorporates volatility (or uncertainty) into the calculation. This contrasts with an “average annual rate of return,” which can be misleading. The chart below shows the annual price returns for the Nasdaq-100 Index (NDX), a basket of the 100 biggest stocks listed on the Nasdaq (think companies like Apple, Amazon, Tesla). Generally speaking, it measures the total gain/loss of those companies for the year:

Nasdaq-100 index annual price returns


Rarely Average

Looking at the chart above, it might not be immediately obvious that the average annual total return for the Nasdaq-100 since inception is +17.10%. However, out of 37 years analyzed, there are only four calendar years that were close to average. Put another way, the NDX performance on a year-by-year is rarely in line with its long-term average. 

For the sake of comparison, the S&P 500 Index (SPX) has an average annual total return of 9.55% since 1986, and like the NDX, has very few years that are close the average.

Since 1986, the NDX has outperformed the SPX on average; keep in mind it has done so with higher volatility. In most situations, the term volatility has a negative connotation and in capital markets, volatility is unavoidable. It is why people choose to invest. Absent a degree of change – there is no incentive to accept risk. 

Congratulations on your accomplishment. Try to invest early and consistently. Always keep learning!

You can learn more about Nasdaq Index Options here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Original Post

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