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10 Simple Rules for Investing Everybody Knows (but Nobody Remembers)
How do we invest? Where do we start?
Investing is scary. What do you invest in? Where do you start? Keep reading and I'll tell you everything you need to know. As long as you know your goals and stick to a plan you'll do fine.
Let me first say that I am not an expert. I have no formal training or certification or anything. All I have is my experience. I have been investing in the stock market for over twenty years. Nearly all of my holdings include simple boring index funds. Because of my investments as well as a very humble lifestyle I no longer need to work full time. I have left the rat race behind forever and live as an expat.
Over the long haul, the stock market is your best friend. Forget dragging all your rusty junk to Pawn Stars. Forget antiques or uncut diamonds or coins or whatever. Now there's absolutely no problem with having hobbies or collections but for building wealth over time, it starts with the stock market.
You don't need a bunch of books, magazine or newsletter subscriptions or anything like that to get strong returns. Anything useful from all that stuff is what I'm about to tell you. Everything else will get in your way. It's actually all the noise, all the hype that gets investors rattled and jittery. That's when investors make mistakes with their hard earned money.
If you have some experience in investing then you might know most of what I'm about to tell you. It's so basic that it flies out the window when greed and panic set in. Here are some simple rules that everybody knows but nobody remembers...
10. Invest in yourself - Everyday in any way
You may be short on cash but that's not a problem. If you haven't saved any money to invest or just can't then start at the beginning: invest in yourself. You'll never find this in any book about investing but it's the simplest and most basic way you'll always see a return. Now I know this isn't the stock market but it's the best thing you can do if you don't have money to invest. It won't cost you a dime and you can start at any age.
OK but what does this mean? Investing in yourself has more to do with your habits than your money. It's about investing the time and effort to make yourself a better person. There are small things we can do everyday that will benefit us in the long run. For example, if you smoke why not stop? It's hard right? But if you live in New York and can stop for a day you can save up to $30 (if you smoke two packs a day). Also your body will thank you.
I'm sure you can think of lots of other ways to save money but it's also about learning things. You keep your brain forever so invest some time in learning something useful. Why not pick up another language? I live in Japan so I'm trying to learn Japanese.
By the way I also know a little bit of Korean. Learning Korean seemed like a good idea when I was in the Army. After all, every American soldier ends up stationed in Korea at some point. Books and classes cost money but if you have a few minutes to spare check out duolingo.com. It's free.
The possibilities are limitless. Anyone can get more exercise, eat more fruits and veggies, make more friends or even start writing articles online. A few useful things to learn would be basic first aid (including CPR), driving a manual transmission or public speaking.
Do you know how to start a fire? OK, then learn how to put one out.
9. Don't invest in the stock market - Until you get your house in order
Maybe you have some money to spare. That's good. Now take a look at the big picture: everything you own, including all of your debt. This seems so basic but nobody does it. People often compartmentalize money. Investing is separate from personal finance. The idea is that investing is exciting and personal finance is boring.
Simply put, it doesn't make sense to invest three thousand dollars in stocks when you have ten thousand dollars in credit card debt. You may have a lucky run and make a 10% return but it pales in comparison to the 27% you're paying in interest. Also, stock returns can change--that 10% gain might be only 5% next year. This doesn't include any capital gains taxes or trading fees. At the same time your credit card debt will cost you the same 27% next year.
So before you consider investing, take a step back and look at all of your accounts. I've used Quicken for over a decade but it's expensive. There are plenty of websites that help you organize your finances just as effectively for free. My sister swears by Mint.com but I've never used it. Or if you want to keep things simple, just write everything down on a sheet of paper. Include interest rates and annual fees.
Once you have everything listed take a good look at any debt that charges you over 10%. This will include credit cards but maybe also a car loan. Use any spare cash you planned on investing to knock off as much of this debt as possible. Remember this is "any spare cash you planned on investing." If you have money set aside for a rainy day don't touch that. Also if you've already set up a 401k at work that's fine too.
The Millionaire Next Door is not about the stock market. It looks at the big picture. Why does the family next door make the same money you do but have five times the net worth? What are they doing differently? What are they teaching their children? Why will these lessons work in good times and bad? Take a look!
8. What are your goals? - Remember them and stick to them
So now your most expensive debt is gone and you have some money to invest. Now what are your goals? To make tons of money right? Great! OK now why? What would you do with tons of money? These questions seem obvious which is why people ignore them. Those who do make goals often don't remember them.
Take a few minutes and daydream a little. What do you want with your money? Retirement is a popular one. Let’s use that as an example. If retirement is over twenty years away then it’s OK to get aggressive with stocks. You may lose money now and then but, depending on how much you invest, you should have a nice nest egg when it’s time to retire. If retirement is much sooner, include some bonds. Bonds are much safer. They focus on income.
Once you have a goal in mind think of a plan. Once you have a plan stick to it. Don’t worry about how much money Warren Buffet made, don’t worry about how much money anybody made, don’t worry about returns of the rest of the market last year. Forget all that. Just stick to your plan.
It’s OK for goals to change. You still want to retire in twenty years but you want a house in five. Most people can’t afford a house so they go for a mortgage. But the bank will expect a heavy down payment. The closer your goal is the safer you should play it.
Try to keep your goals realistic. The stock market has done some wild things now and then but over the long haul (more than 10 years) I don’t expect more than a 4% annual return after taxes and inflation. With bonds, I don’t expect more than 1%.
7. Start with an Index Fund - What's an index fund?
An index fund is a mutual fund that tries to mimic the returns of a stock market index. The most famous stock market index is the Dow Jones Industrial. Another famous one is the S&P 500. So an index fund will buy all the stocks of the index and that's it. If that sounds boring that's because it is.
Boredom is the biggest drawback of an index fund. The advantages are plenty. An index fund offers instant diversity because it holds so many stocks. Also because the idea is so simple, you don't need a bunch of Ivy League MBAs in power ties charging heavy annual fees. You don't need to worry about some fund manager turned celebrity going to another company.
Another plus is that the turnover is low. That means an index fund buys stocks to own them, to mimic the returns of the stock market index and not to sell them later on for a quick profit. Less churning means less capital gains taxes. Finally, because index funds are so simple they consistently beat the returns of most actively managed mutual funds over the long haul.
Index funds have caught on so lots of mutual fund companies offer them. But the company that started it all is the Vanguard Group. Its most well-known fund is the Vanguard 500 Index Fund.
DISCLOSURE: I currently do not own any shares of the Vanguard 500 Index Fund but most of my holdings are with the Vanguard Group.
The video below best describes an index fund without trying to sell anything.
6. Shake the hype - All of it
If your holdings are in index funds then you probably realized that you are not glued to your TV for the latest financial news. You’ll find that you are not glued to your computer monitor looking for the hottest stock the day traders are juggling. Your investments are not keeping you up at night.
You might get a quote (check the prices) every day but you won’t need it. Later on you’ll check quotes once a week or even once a month. This is actually a good thing. Investing doesn’t have to be a full time job.
The books, magazines and newsletters are out there for one thing: sales. The writers and publishers want your money. The TV shows want one thing: ratings. The websites want one thing: traffic. Even I want traffic (but I don’t need it). None of these folks care if you make money.
There’s so much information out there that the stuff that stands out will always be the craziest and zaniest gimmicks. Nobody is going to spend twenty-something dollars to buy a 300 page hard-cover book titled, “Index Funds for the Long Term.”
Everybody knows this is all hype but they get hypnotized. They keep buying and watching. They stop thinking and start believing. This is when investing becomes speculation (also known as gambling). Gambling is not investing. Also one thing I notice with gamblers is that they don’t stop when they’re ahead. They only stop when they’re totally cleaned out.
So please ignore the hype. Forget about the dying industry titan that will suddenly make a turnaround just because you bought its stock. Forget about that tiny pharmaceutical company that will cure cancer and make you tons of money. Forget about that tech company that will be bought out because it does something you can’t explain much less understand.
Sure you’ll have a few cool stories but that’s about it. Remember: stick to your goals.
5. When to buy - This is actually easy
When do you buy? This is easy. When it comes to index funds buy when you have money to invest. Don't wait. A lot of people sit on the sidelines. When prices are low they might get scared, especially if they're watching the news about the doomsday economy.
Or they'll say "Let me wait longer to see if the price drop lower." Then when prices are high, they'll say "Prices are too high, let me wait for them to drop." Or they might kick themselves for missing the profit and walk away altogether.
Start when you can. Most index funds have a "Minimum Investment" amount. For some funds it's as low as a thousand dollars for others it can be as high as five million! Start at the minimum investment and buy monthly.
Now invest the same amount every month no matter how much the price fluctuates. Don't worry, when prices are steep you will automatically buy less and when prices drop then you will automatically buy more. You will win as long as it's the same amount each month.
Most mutual fund companies can help you set up a monthly investment plan. Or if you can do it yourself as long as it's something you can put on autopilot. It will seem weird but if it's an index fund you'll actually look forward to days when prices fall. You'll dread days when prices are high. I know I do!
What you don't want to do is stir things up. Don't complicate things. This is easier said than done because it's so simple. Over the long haul the stock market outperforms every other kind of investment there is. Remember your goals and stick to your plan.
The movie Margin Call is about an investment bank in the middle of the recent financial crisis. If you think about it the whole financial crisis is about investors at all levels who took too many risks and invested in things they didn't understand.
4. When to sell - This is harder
Maybe you own a fund or even a stock. When do you sell an investment? Eventually we all sell--that's the whole point. But knowing the right time to sell is probably the hardest part of investing. Some expert might say something meaningless like, "Can't hurt to take a profit." OK! Good job high-speed here's your own TV show!
Here are a few questions to ask before you sell...
- What's the reason you bought it? Is it still there? For example, let's say you have a few shares of a ginormous soda company. It's spent nearly a century building its brand and its distribution chain. Its profits are massive and everyone loves its product. If it decides one day to leave the beverage industry forever and go into privatized space exploration then it's time to sell. By the way this is not likely to happen with an index fund.
- Did you meet your goals? Or did they change? Most people invest for retirement. Time goes by and as retirement gets closer it's time to shift from stocks to something more stable like bonds. Yes there are index funds for bonds as well. Market fluctuations won't bother you and your portfolio will develop more income. Then when you finally reach retirement start selling your bond funds. In other words, cash out and enjoy retirement!
- Are you rebalancing? Rebalancing your portfolio means buying and selling to correct your asset allocation. For example, you've invested 50% in stocks and 50% in bonds. Your bonds yielded income but when it comes to value the winner was stocks. Your portfolio on the whole has increased in value but the assets are at 60% stocks and 40% bonds. Now it's time to sell some stocks and buy some bonds. How much of each? Until you're back to your original goal: 50/50.
3. Include all of your investments - Don't lose track of anything
We talked about this earlier when looking at debt. If you did this you probably realized that you already have investments. You may have started a 401k with a company you worked at for a few years. (By the way, regardless of your financial situation investing in a 401k is always a good idea.) Or maybe you inherited some bonds from your grandmother a while back. This is all your money so don't forget about it!
When I was in the Army I started a TSP account. The Thrift Savings Plan is the 401k of Federal government workers. I completely forgot about it until recently. It's not a lot of money but it made me rethink my asset allocation.
The reasons people don't do this is that they forget about these investments or they think the money won't make a difference. Not true. Or even if they remember them in the beginning, they don't remember to include them when rebalancing. Not cool.
So scour your brain once a year, remember all of your accounts and include them all into your plan.
2. Want to invest in individual stocks? Remember this...
You might want to invest in individual stocks. Even with index funds you may have extra cash to invest with. Here are some questions to ask yourself before you do:
- Why are you interested in individual stocks? Do you want to "make a killing" as a day trader or are you genuinely interested in investing in businesses?
- What would make you choose one stock over another? There are a lot of companies out there. Is it the hype? A tip from your friend or a forum?
- Do you know what a 10-K is (an annual report)? Do you know what a 10-Q is (a quarterly report)? Do you know how to get one from a company you're interested in?
- Can you sit still for hours reading a bunch of boring information and looking at financial data several times a month? Do you have the time?
- What's the difference between price and value? Are you better at finding value than thousands of computer programs, experienced analysts and hedge fund managers from all over the world? Can you do it every day until you reach your goal?
- Let's say you bought a stock. If its price plunged 30% in a week, what would you do? Buy? Sell? Hold?
1. Humility - Learn it now, not later
I’m not trying to scare you but it’s very tempting to buy into the hype. It’s easy to get overconfident especially when looking at the past. Your friend thought so too until he got cleaned out in a couple months. Seeing someone else tumble it’s easy to say, “That would never happen to me,” or “I’m too smart for that.”
Thinking like this gets people dreaming. “Yeah, I can do it. If I try hard enough, I can jump in and out and make some serious money. Then I can retire early/get my kids through college/buy a new car. Let me give it a shot.”
These voices get louder because we only hear about the winners. And who is telling us about the winners? The experts sitting on the sidelines. Yes lots of them are making their money too but they aren’t in hurry to tell us about some of their past mistakes.
Before you start acting on your fantasies, take a deep breath and snap out of it. Humility is the most powerful thing you can learn here. Not a lot of folks will tell you about it because it doesn’t sell anything. It’s better to accept your limits now than after you’ve lost thousands of dollars you couldn’t afford to.
Play it safe. Remember your goals. Stick to your plan.