It seems like every day “the market” hits all time highs and everyone and their dog are investment, day-trading gurus that are reaping huge profits from the winners they’ve picked. Everyone has investment advice and it can be easy to feel like there’s a ton of money just being handed out. What few people will admit, or know, however is that it’s easy to make money when there’s a huge upward trend in almost every asset class. Assuming you’ve got your personal finances under control, debt AND emergency savings, take a minutes to learn how to build a solid foundation on which to secure your financial freedom.
What exactly is “the market”, stocks, and how do they relate to mutual, index funds, and ETFs? Simply put, stocks are tiny stakes of ownership in a firm. If the firm does well, your tiny share grows in value and vice-versa. Mutual funds, index funds, and ETFs are a basket of investments packaged into one easy to trade security. They contain anywhere from dozens to hundreds of stocks and sometimes other assets like bonds and real estate. The biggest difference in each tends to be the goal, strategy, and benchmark each measures its success by. The market is simply a place, or series of computer networks that allows buyers and sellers to come together to transact with these investments. This of course, is just the tip of the iceberg but as a beginner don’t worry about trying to understand the very complex investments that stem from these simple ideas just yet.
Next, read. Educate yourself. The authors of a handful of financial books hold more combined knowledge and wisdom than any one individual ever will and have already gone through the trouble of documenting it for us. Be smart and take advantage of it. Instead of succumbing to emotions, financial rumors and misinformation, be rational and educate yourself. For starters, there are 3 books I wish I would’ve read before I ever purchased my first shares of stock years ago. They are The Intelligent Investor, Security Analysis, and A Random Walk Down Wall Street. This should be required reading by anybody wanting to buy into individual stocks. On top of these classics, make sure to stay up to date with financial markets as much as possible, however be wary of most financial publications.
We live in the era of information, or perhaps the era of misinformation. There is no shortage of business channel or magazine touting the next visionary leader. Ironically, the same publications that put the leaders of today’s hottest company on a pedestal, are the same “journalists” that crucify them later when they fail to live up to the hype. But it sells. Every segment of the news is the same length of time day in and day out. Those slots have to be filled. These media outlets make money hand over fist from powerful investment banks that in turn make enormous profits from the business generated from all of the noise that comes out daily. Just know that most of what goes on is not relevant to a long-term strategy. I personally only take a couple of publications seriously, everything else is just entertainment and a source of ideas for contrarian investments. Modern Trader and Technical Analysis of Stocks and Commodities are a couple of my favorites, and even though they are highly technical and geared towards the more analytical crowd, I have to remind myself that these magazines sometimes also get caught up in the madness that is Wall Street.
Now that I’ve briefly gone over the concept of what equities and financial markets are, and the importance of educating ourselves as investors, now comes time to be honest with ourselves. Some simple introspective questions to start asking are: What type of investor am I? Can I stomach large swings between ups and downs? How much time am I willing to dedicate to this? Is this something I am genuinely interested in? Why?
In all honesty, most people lack what it takes to be successful active investors. Markets are irrational and sometimes that can mean terrible days to the downside. How much red are you willing to take on your portfolio before you give into a panic and sell what you still have? A disciplined active investor must be able to handle the market’s irrational behavior and stick to their research and strategy. At the same time, one has to be vigilant and constantly processing new information to find opportunities and adapt their portfolio accordingly. I spend 10-15 hours per week outside of work keeping up with and researching individual stocks, ETFs, mutual funds, and general market events. The world changes rapidly and only those that can effectively filter material news from market noise will have any sort of shot at consistent, long-term success. Those that don’t, have to be willing to give up their sleep, youth, and sanity (not to mention money). As demoralizing as this may come off as, don’t let me discourage you, I’m simply setting realistic expectations.
Being an active investor isn’t for everyone, and that’s fine. The beauty of a free market is that it allows for specialization. Those with the skills and passion to pursue a career in finance can do so for everyone else that’s not. The best option for most people is to put their money in something passive with low fees and volatility that won’t eat up returns.
I’m almost always recommending to friends that don’t want the stress and burden of managing money to invest in a low cost index fund like the Vanguard S&P 500 $VOO and enjoy their life. Index funds are a specific kind of ETF that provide probably the easiest way to diversify equity holdings and have exposure to the amazing historical returns of the overall market. Perhaps the only worry investors should look out for when investing in index funds is that costs are minimal since their only goal is to mimic the returns of the overall market. If aiming for average returns isn’t good enough, ETFs also offer a solution for the more risk tolerant investors.
The recent skyrocketing demand over the last couple of decades by retail investors for baskets of investments that span just about every investable strategy one can think of, has given rise to the popularity of ETFs. There are ETFs for those that want to invest by specific sector, geographic region, or asset class. There are even ETFs that invest using very specific investment philosophies. There is probably an ETF for every imaginable investor. They’re a great way to diversify over any given investment strategy. ETFs trade just like stocks over an exchange, so liquidity is almost never an issue. They also usually have the lowest fees of most managed investments. However, depending on the type of ETF, they can be risky and volatile. Do research on the prospectus (the goal, strategy, and benchmark) of each ETF as well as the management, and of course the fees.
Another very popular way to invest across many individual stocks and assets is through mutual funds. Mutual funds are very similar to ETFs. Mutual funds pool money from thousands of investors and put it into different companies and assets. Two of the biggest differences are in their fees and ease of use for recurring automatic purchases. For the most part, mutual funds are more actively managed and therefore have higher fees. Some funds charge a commission up-front and have lower annual maintenance fees while others have no commission but higher annual maintenance fees. They are very widely used because it’s easy to set up automatic contributions into retirement accounts taken from every paycheck and because investors can buy fractional shares. Some people would not otherwise make contributions if they were not automatic. Dollar-cost averaging, the consistent buying of mutual funds every certain period of time over many years, has been an incredibly powerful technique to grow wealth and the popularity of mutual funds.
Another fairly passive investment I like are holding companies. They carry more risk as they are not as diversified as most mutual funds or ETFs but are an easy way to gain exposure to the returns of legendary investors like Warren Buffett and Carl Icahn.
Everyone knows Warren Buffett and of his genius ability to consistently beat the market for four decades now. Berkshire Hathaway $BRK.A shares are over $283k as of 10/25/17 and are out of reach for most investors however there are Class B shares that average investors can pick up for $188. Shares are up 16% YTD, not bad. Mr. Buffett has ownership stakes in everything from Coca-Cola to various airlines but it’s important to remember that it’s core holdings are still in the insurance services.
Another way to invest alongside an actively managed celebrity investor is through Icahn Enterprises LP $IEP. One of billionaire investor, Carl Icahn’s most notable investments in recent years was in Netflix. He turned a $321m investment into almost $2b. Although $IEP is currently facing some historical resistance in the $55 range, the stock has a dividend yield of over 10%. He’s most recently been busy with investments across various auto repair shop chains and up until August, an informal advisory role to the Trump administration.
I was initially also going to briefly go over banks and financial services separately from individual stocks but changed my mind as I don’t want to turn turn new investors away. I thought I would include banks because as gatekeepers to all things financial, they are able to cater to those sectors that are “hot” and ride their waves through investments in, lending to, and through general investment banking revenue in those markets. But banks are a different animal all their own. Along with making and participating in those markets comes exposure not just to the firms they do business for but also exposure to geopolitical risks that I just cannot cover in a piece for new investors. Understanding their holdings requires an incredible amount of time and understanding of financial markets, both of which most newbs won’t have. Investing in individual stocks also requires those stipulations. That’s why investing in individual stocks, especially banks is just not for beginners. Put your money only in those things you understand.
Once again, don’t let my opinions discourage you. In fact, I hope they motivate people to take the time to become knowledgeable investors that think for themselves. Today’s market has simply created a false sense of security due to many factors new investors don’t understand. New investors reaping large profits today while unknowingly taking on more risk tomorrow, could be financially set back years if the market takes a turn to the downside. You don’t have to be a Chartered Financial Analyst to invest but do take at least a few days to research some of the investment ideas I’ve presented. Once you’ve become familiar with mutual funds, index funds, ETF’s and diversification, I hope you guys better understand what type of investor you’d rather be. And if you still feel that you want to manage things yourself and be in control, then by all means let me help you.
Disclosure
I do not own shares of any of the securities I mentioned nor do I plan on initiating a position in any within 72 hrs. Do your research and know what you’re doing before you put your money into anything I give my opinion on. I was also not compensated by any of the firms I mentioned.