How Not To Suck At Investing

Here’s the problem about investing – we know that it’s good for us, but most people suck at it. We all have an uncle somewhere who lost his entire retirement savings by betting on Asian stocks in 1997, tech stocks in 2000, or financial stocks in 2008. He held on to his portfolio as the market plummeted, losing thousands of dollars every day, until he couldn’t take the pain anymore and got out.. only to see the market climb back up again. On the flip side, we see research that says individual investors pulled more money out of the stock market…. only to watch the Dow march higher and higher. (as reported in the WSJ)

There are thousands of reasons why people suck at investing – behavioral biases, having way too many choices, overconfidence, etc – but I think the number one reason is that people just have the wrong idea of what investing actually is. Here’s what runs through most people’s heads when someone tries to talk to them about investing: “Investing… how to get rich! Picking stocks. What stocks do I pick? Maybe Facebook. Or Apple. Hope the price rises by like 10x next year and I’ll be RICHHHHHH. Ca$$$h money baby!!” Zomg. Kill me now.

Newsflash dude: Investing isn’t about picking stocks. I’ll say that again: Investing isn’t about picking stocks. Now say it to yourself three times every night before you go to sleep.

Okay I’m hearing the crowd of angry “investors” outside my door, armed to the teeth with pitchforks and torches right now: What?! It’s not about picking stocks?  But Warren Buffett, the world’s greatest investor, says we should pick good businesses at cheap prices, and hold them till like, FOREVER. And then we’ll be rich!! True, you could totally do that successfully… if you were Warren Buffett. He owns Berkshire Hathaway, a company of full-time, well-trained researchers and analysts who spend their entire careers searching for good companies to buy. He has contacts with Fortune 500 CEOs and can meet with them whenever he wants. He understands things about the businesses he buys that no individual investor can even dream about. Now if you think that simply picking up a book entitled “How to Pick Stocks Like Warren Buffett” and flipping through a few annual reports is going to make you a superstar investor… think again.

So investing isn’t about picking stocks. Rather, it’s about putting your money in assets that will grow over time and will generate an income for you. That’s it. Sure, you could plough your money into Facebook or Apple or whatever the hot stock is at the moment, but is there a chance that it could plummet to zero in 10 years? Of course. Companies fail all the time – all it takes is one CEO scandal, one accounting fraud, one new player on the market (think about what Google did to Yahoo), and your company, once the darling of all the investment pundits, is filing for Chapter 11. I’m not saying that individual stocks are bad investments – of course there are many that have a long history of excellent returns – but there’s another asset that provides awesome returns, with way lower risk than any single high quality stock you can find out there. It’s called the stock market. (cue dramatic music – bom bom bomm!!!).

Think about it – companies fail all the time, but it’s impossible for the stock market to go to absolutely zero, unless we get annihilated by a huge alien spaceship, in which case you have bigger things to worry about. The stock market literally comprises of thousands of stocks, and thus for it to go to zero would involve all the companies in it to go bankrupt – ie: extremely unlikely. Remember back in Finance 101 when they used to tell you that diversification is the key to successful investing? Well, buying the entire market effectively diversifies away the risk of any individual company. It’s not entirely riskless (to my financial nerds out there, you still have “market risk” to deal with), but it’s a whole lot less risky than owning any particular stock.

Another thing – the stock market has an impressive track record that’s freakin hard to match. I can’t think of any individual stock that has been around for the entire duration of the stock market’s 200-ish year old history, with a historical return of 7 – 9% per year, depending on who you talk to.

Okay, I’m hesitant to make the ginormous claim that the stock market always goes up – there have certainly been periods where the stock market has fallen, or stayed stagnant – but give it sufficient time (10, 30, 50 years-ish), and there’s a pretty high chance that it is likely to go up. Why do I think so? Three reasons:

1. Inflation – For most developed economies, prices rise. I don’t think we’re going to go back to those times where McDonald’s serves $5 extra value meals 24-hours a day. (no, those lunch hour deals dont count – I swear they cut the patties in half). Prices of things rise over time, including the prices of your stocks.

2. Survival – the stock market will always be comprised of awesome, solvent (ie: non-bankrupt) companies. If a company goes bankrupt, its stock is automatically removed from the stock market index, and replaced by another. Crappy companies get cut out, and replaced by better, sexier companies. Apple may be the most valuable company in the world right now, but in 30 years it could be bankrupt, and replaced by another trendy company where its fashionable for top management to wear tight-fitting black tees. Owning the stock market index ensures that your portfolio always comprises of the best companies in that market. It’s like being able to fire that one douchey, useless employee in your company, without the guilt or death threats.

3. Population growth – Let’s face it, even with the explosion of investable assets today, stocks remain the de facto investment vehicle of choice to most investors. They aren’t as sexy as fixed income or exotic options (I believe the job posting of “equities in Dallas” is still a laughing stock in the IB world), but nothing trumps the liquidity, the ease, and the transparency of the stock market. And as the world gets larger, more educated, and richer, guess where’s the first place they’re going to plonk their money into? That’s right – the stock market. And Economics 101 teaches you that as demand rises… so will the price.

Notice that everything I mention here is about really large, long-term macro trends. In all likelihood, prices will rise, good companies will replace bad ones, and the world population is going to get larger. I haven’t even talked about the number one economic reason why I think the stock market will rise: Because it’s comprised of businesses. Hundreds and thousands of businesses that earn more every year, year after year. Essentially, buying the stock market means putting your money behind the fact that business will continue throughout the world. And in my opinion, that’s a pretty strong bet, discounting the scenario that the world dissolves into anarchy and we all degenerate into Fred Flintstones. (Always wanted to try those cars with no floors that let you walk everywhere)

So how would you be able to own the entire stock market? It used to be ridiculously expensive to own the entire market because you would have to buy thousands of shares, but now you can do it with a low-cost index fund or ETF (but I’ll leave that for another time).

But don’t take it from me, take it from Warren Buffett, who mentioned that a low-cost index fund, is probably “the best investment that most people can make.” So you may not be able to invest like him, but you sure as hell could take his advice. Think about it 🙂

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8 thoughts on “How Not To Suck At Investing

  1. Pingback: It’s Not About the Timing, Timing, Timing | cheerful.egg

    • Love the article! I might even blog more about it, but some random short thoughts in the meantime:

      1. Equity risk premium has been declining, but what are the alternatives? Investing in T-bills that cant beat inflation? Or exotic derivatives that we can barely understand?

      2. Everyone knows that 2000 – 2010 has been a crappy decade for stocks. But this isnt the first time in history that the stock market has been stagnant: 1935-1950, 1965-1980 are also good examples of 15-year cycles that the market stayed at the same level. But those still dont affect the overall great performance of the stock market historically.

      3. A good portfolio would comprise of both equities and bonds (among other assets) for diversification. So while the declining risk premium may bring the performance of the two closer together, it’s not as if you’re “missing out” but being completely uninvested in bonds.

      4. Let’s not forget the effect of dividends, which, when reinvested, account for half (? I think) of the total gains from equities.

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