I’ve been out in the working world for just about a decade now. I’ve learned a lot, have had lots of crazy experiences, and have made some good financial decisions and some not good ones too. I think that the longer I live, the more of what’s important comes into focus, and I start learning to tune out the stuff that doesn’t matter and focus on what does.

One such area that I’ve been particularly focused on is earning a good return on my investments. In the past I’ve tried to overly diversify, get into more exotic investments that may or may not have worked out, and also just kept things boring with index funds. As cool or as fun as an investment may seem, I’ve now learned to measure it against a very standard investment that I make and to use that benchmark as a measuring stick for all my investing. Let me tell you why I overly focus on 8%.

What is an index fund and why is it so awesome

Simply put, I believe that index funds are the best way to invest your money in the stock market. I say this after years of investing on my own and seeing my hard work in picking stocks earn less than an automated index fund would, and after doing research into the average returns and realizing that ultimately year over year picking a generic, low cost index fund will give you a better return and less risk.

An index fund is a basket of stocks that you buy into. Unlike picking an individual stock in which you just are a partial owner of one company, buying into an index fund means your money is divvied up across dozens, hundreds or even thousands of individual companies. There can be different flavors of index funds, some focus on US stocks, some focused more internationally or geographically, or some focused on certain industries.  

While some stocks go up, others will go down, and it’s tough to pick a winner that will consistently perform. Index funds are great because they essentially track the overall market, so for every loser there’s a winner and overall the fund typically does well.

Historically speaking, the US stock market, on average has returned a 8% return. There are years that end up being higher than that and of course years that are lower (or even negative) but on average you can expect 8%. This is where the 8% number came to me.

Why it’s important to diversify but not too much

There’s an old adage that it’s important to not put all your eggs in one basket, i.e. it’s important to diversify. No investment is without risk (no risk, no reward), and so it’s wise to not put all your money into one single investment. Hopefully it’ll increase in value but it might not, there are no guarantees. By diversifying (hence an index fund), you are able to lower your overall risk. However, I’ve gotten myself into trouble before by being a bit too diversified – i.e. I was in too many investments.

In the end I found that I was just diversifying to diversify and when I sat down to track it all I was in too many investments and that ultimately I was no better off than having put it in an index fund. Sure having stocks and crypto and a bunch of different mutual funds might seem good on paper but it’s the 8% that I should be keeping an eye on. If the return I got was right around that 8% number, I might as well save myself the work to manage it all and keep it simple!

Why anything less is a waste  

Now that I’ve got my measuring stick of 8%, I use that as my gauge. While I’m not opposed to taking on new investments, I’m giving careful consideration to the expected return. If it’s less than 8%, would I, could I, have been better off just putting that money into an index fund? I’ve been burned before chasing what I thought were strong investments but in the end an index fund would be done the trick, probably with a lot less work and stress on my part!

Now I do understand and appreciate that an index fund is not without risk, and that the 8% is an average. There will be years that number is lower, and also I’m not going to be 100% invested in index funds. I do keep some money in a high yield savings account, where it’s guaranteed against loss by the US government (arguably the least risky type of investment…if that fails we’re in big trouble!). However I know that I could be taking on more risk so for every dollar in my savings account, I’m aware of the need to get that 8% return somewhere else.

The 8% rule is proving to be a great measuring line for me. It’s helping me stay focused and not take on more risk or even more work for my money, and also reminding me to take risks vs. just a savings account.