Learn To Invest
So you want to learn the basics about investing?
Great. You’ve come to the right post.
My thoughts on the subject aren’t revolutionary. It’s based on knowledge that has stod the test of ages. It’s simple but sound advice.
Still, take what you agree with, ignore the rest. Below you’ll find a table of contents. Jump to a certain section or read the whole article.
“This message is brought to you by:”
These days, everyone’s a savvy investor, at least that’s how they portray themselves. But many forget an important rule in investing.
Don’t invest in shit you don’t understand.
Today there are all kinds of finical products. Many lack knowledge but get sucked into empty promises. This leads them to buy shit products.
Why?
Desperate people looking for quick riches fall for the “finical gurus” of our time.
We all know of which gurus I’m referring to. Those on social media promising their followers ridiculous returns.
These people promote investment vehicles ranging from complex to super fucking shady.
Crypto, option trading, forex trades or whatever new methods they’ve created to fleece people of their money.
They promise unrealistic returns, praying on people that doesn’t know better. Many are desperate. And many fall for it. It’s sad but it’s the reality.
People who want fast results burn themselves all the time. Investing beyond your competence is a good way to get fucked by the markets. It’s that simple.
A perfect example of this is YOLO bros using leverage. Life is awesome when you’re winning. That leverage makes total sense. You’re a fucking genius. At least that’s what you believe. But, as you’ll come to realize, leverage goes both ways. What goes up, must come down. Lots of people fail to realize this. Everything is great until it isn’t. Your nice rise becomes your catastrophic downfall.
If you were to take one lesson from this piece, it’s this:
When you’re new to investing keep it simple.
Avoid getting fancy. Be boring. Go for index funds.
Index funds? Really?
That’s correct. I let you in on a secret.
Most people should buy index funds. Smart people. Dumb people. Savvy investors. “Basic bitch” investors.
Index funds is great for everyone.
That is what research on the topic of investing says. If you have heard different, who’s giving you investment advice? Do they stand to make money from your choices?
What incentives do they have? If they make more if you choose a certain fund, are they giving you the best advice or the best advice for them? Always keep that potential conflict in mind.
Only owning index funds can be boring. I realize that. Finding a balance is key. I understand the need to spice things up. Nothing wrong with that.
But with that said, for the love of God, don’t do a WallStreetBets.
This is your life. Reading about other dumb fucks is entertaining. But avoid being the one providing the entertainment at all cost.
I believe in having a majority of my wealth in index funds. It’s simple. It’s cheap. It’s a proven bet.
Set a side a small portion of your portfolio. When you get that itch, use that money. Buy that stock. Make that option bet. Or buy that digital art you like. If this portion goes up, great. If it goes to zero, who cares?
I’m not new to investing. I’ve been doing it a couple of years. I’ve picked stocks. I was okay at that. I made money. I’ve done a couple of alternative investments.
I found out that, over time, the stock market is hard to beat. That’s why I mainly invest in index funds. Because despite what the finical gurus of the social media world says, investing is hard.
Professional investors out there underperforms the market each year. It’s their job. They spend hours thinking about investments. Most of them are wicked smart. Yet they still fail in beating the market. Because it’s hard work.
If they can’t do it, what makes you think you can? You have a job of your own. You have obligations to your family and friends. You need to cook, clean, wash clothes and the list keeps on going. Add to that working out and hobbies.
With that outlook, you have the odds stacked against you. Your chance of beating the market, long term, is slim to none. Disagree all you want with that statement. Keep one thing in mind. You have a mountain of evidence that says otherwise.
Lets jump in.
You got to crawl before you can walk
Before you start investing in anything you should have an emergency fund.
That might sound boring. And it is. But when you have it, you’ll be so fucking happy. Trust me. An emergency fund gives a peace of mind.
Stress is living paycheck to paycheck. Living within your means, having a safety net, is bliss.
Ditch the common advice with “emergency fund first”. In my opinion you should do the following. Decide how much money to invest each month. Divide that money between your emergency fund and investments.
A majority of the money should go to your emergency fund. That is a lot more important to build than your portfolio. It’s your life line during hard times.
Overtime, as your fund builds up, you can adjust the proportions, tipping the scale toward investments.
The world of investing can be a jungle. Begin investing in one or several index funds. Be a regular buyer. The market fluctuates. Sometimes wildly. That’s normal. But prepare yourself. Because it’s easy to get scared and do dumb shit.
Don’t be a moron
Many factors are impossible to control when it comes to investing. You can make a great analysis and still get killed in the market.
Why?
Because it’s made up of humans. No matter what we tell ourselves, we aren’t rational beings.
Let’s admit it. We do dumb shit all the time.
We hype companies to massive valuations (WeWork, Tesla and so on). Many of them will never live up to the hype. Other times we sell great companies because they are boring. We want action. We crave flashy stocks.
Many seek thrills in the market. Seeking that rush. That is a great way to lose money.
I invest to make money. To me, finding thrills in the market is wrong. That is gambling which is different from investing.
Investing should be boring. It should be methodical.
You should never make investment decisions in a hyped state of mind. Rushing is bad. It leads to mistakes.
Since investing is decision-based, you should focus on your process. Outcomes will vary because you can’t control the market. At times, it does crazy shit that makes no sense. But you can control your decision process.
Following a decision process could help you when the market turns downwards. It doesn’t need to be complex. A simple question could be: Am I acting out of fear?
If you are genuine in your answer to that question, you could avoid a common mistake. Panic selling.
Making bad decisions is a part of life as well as investing. Your job is to create a large enough margin of safety to be able to handle it.
One bad decision should never be able to ruin you.
Never go all in on one bet. Never panic sell. Use leverage with utmost care. Avoid complex products nobody understands.
Keep it simple and don’t be a moron. If you do that over time, you’ll have amazing results. Despite only owning index funds.
Speaking of time, let’s talk about that next.
Time as an asset
As an investor time is your friend. In fact, as a small investor, it’s one of your most important assets.
I say assets because this is an edge you can have over professionals. They have demands on them. Those demands makes them prone to acting. Turn that into an edge. Quite often, doing nothing is the right call. That is counterintuitive, but ring true many times.
Time in the market is incredibly important. This is important to understand. Missing out on a few days can have a severe impact on your portfolio’s performance. Even years after the fact.
Yes, that is correct. A short timespan might make or break you if your out of the market. Think about that before you panic sell the next time.
Time in the market is a thing. But is timing the market something to strive for? Can you buy low, sell high?
Probably no.
Of course, there are exceptions. Someone will interject by saying “I did it, that is proof it can be done”. To that I say, stop bullshitting yourself. You got lucky. You might not know it. But that is the truth.
Don’t believe me? Trying doing it again. I dare you.
Timing the market sounds great. As an idea, it is, but in practice is nearly impossible to do with consistency.
Turns out that is fucking hard. Go figure.
As we’ve already established, investing is difficult, so why do you want to make it harder?
Many have believed they’ve cracked the code. With a remarkable accuracy, that turns out to be wrong.
Models accurately predicting when to buy and sell is, with a high probability, a pipe dream.
Market fluctuations have many reasons. One of them is the irrationality of people. Building a model that takes into account all factors is impossible.
If you have enough capital, knowledge, and time, you might come close to the above. But it’s a strategy that should be left to the pros.
Research says that normal people should adopt a simple buy-and-hold strategy. It wins over time.
It’s not impossible to time the market. While difficult, it can be done. But for most normal investors, it should be anything to strive for. If successful, it’s often luck, not skill.
That can become an issue. People get overconfident. They think their timing was anything other than luck. They fail to realize a crucial part. Begin correct one time says nothing. What about a couple of times? Nah. Chances are that its luck.
To paint a picture of how this could happen.
Let’s say you’d base your investment decisions on a coin flip. Heads you sell, tails you buy. Let’s say you flip the coin 5 times, each time making the right call.
From the outside perspective, you’re an investing God. Your able to time the market perfectly. But that is still luck and flipping a coin isn’t a sound investing strategy.
We often believe we can forecast the future. But we can’t. We suck at it. That is why a model might work for a time, but end up in failure. Sometimes in spectacular fashion.
When Amazon told the world they were buying Whole Foods, the market went crazy. It was a negative spiral for the competitors.
Based on what?
Rumors and fear. Irrational behavior ruled the market.
Political events, large mergers, or other types of announcements can make people do crazy shit.
Remember when Trump won the election in 2016? A lot of people, believing to be able to predict the market, took short positions.
They lost a lot of money doing that.
Timing the market is the same as predicting the market. It can be done by luck. But it’s rare that it’s done by skill. Skill means your able to do it over time.
Investors believe they have this skill. But they often don’t. That is what the research says. Behavioral Investing by James Montier is a great read if you’re interested in this topic.
Dalbari is an independent investment research firm. They have made one thing clear through their research. Investors are their own worst enemies. Because we are irrational. We can’t help ourselves. We do dumb shit.
Their research shows that during the period 1985 - 2015 the average equity fund had annual returns of 3.66%. That was the professional’s returns. How did, for example, the S&P 500, perform? 10.35%. Annual returns.
Those numbers show that it pays to follow the “buy and hold” strategy. At least for most people. I dedicate a couple of hours per year towards my investments. Despite that, over time, I’ll outperform many of them.
Why?
Broad funds with low fees, held for a long time, is very hard to beat.
Speaking of fees. Let’s discuss the finical industry’s favorite way of ripping you off.
Fees
Good investors know that two factors will have a major impact on their performance. Fees and time in the market.
High fees are the enemy of all investors. Always keep an eye on your fees. They kill your returns.
You should be sure that the fee is worth it. In most cases, it’s not. I’ll get into why that is.
When investing in funds, fees become central to your performance. It is one of the strongest indicators of how a fund will perform in the future. History, on the other hand, tells next to nothing about future performance.
Why?
A cheap index fund cannot come out on top. It aims to be average. But by it’s very nature, history favors the bold. A successful fund wins because it went away from the consensus. This means taking on a kind of risk. That choice can turn out to be bad or good.
That statement tends to confuse people. But think about it. Someone needs to decide what to do. An index fund buys the index. An active fund has investors making decisions. That requires compensation which they get from fees. But why would that be a problem? Simple, having high fees makes it much harder to compete. It’s the equivalent of having to start 15 meters behind in a 100 meters race. It can be done, sure, but it will be fucking difficult.
When people choose the best active funds to invest in, what do they look for? Historic performance. This means they buy the one with the most risk, and thus the highest potential for failure. Add to that the all important fees. This makes it hard for active funds to outperform an index over time.
Let’s see with an example what impact fees can have.
You got two funds, A and B. You invest the same amount of money in both. 100K. Both funds return an average of 8% during a 20-year period. The only difference is the fees. Fund A has a fee of 0,7% whilst fund B has a fee of 0,1%.
A small difference you might think. But after fees, what do you think the difference in capital is?
- In favor of fund B. That is a huge difference.
What would happen if fund A was an active fund? In general, these types of funds have a higher base fee. But they also have more kinds of fees, turning a bad situation into an even worse one.
That would mean they must outperform a cheap index fund by a lot to be worth it. Am I saying active funds are bad?
No, my point is that choosing an active fund over an index fund is a risk few think about. Lots of active funds will underperform their index. Others will outperform. But how can you know? Are you sure you picked the right active fund?
You have no way to tell. Historic performance says nothing about the future. All funds have professionals working for them. Smart people trying to outsmart each other.
An active fund that makes a great return also took a great risk. They made a killing because they went against the consensus. It could have gone the other way. Be wise in your decision if you intend to use active funds. History can be a deceitful bitch.
Be average from the start
As you are a smart person (subtle flattery, I know), at this point, you know I like index funds.
I like index funds because their easy to understand and invest in. They are cheap. Since they reflect an index, they tend to be broad and diversified.
What makes index funds special is that they make something incredible possible. Average people can be average from the start.
Think about that for a moment. When you pick up a new skill, you suck. You’re far from average. But in investing, it’s easy. Just by buying an index fund, you become average.
That to me is unbelievable.
I said it before, but it bears repeating. By using a buy-and-hold strategy, I can outperform professionals over time.
You realize that is crazy right? You’ll never be the best performer. But you won’t the worst either, and that is a wonderful thing.
By investing in an index fund, you’re not actively trying to beat the market, you simply follow it. That is why you’ll always be average. That might sound boring to you. Good. Investing isn’t a place for excitement. Find your “kick” through other activities.
Or, if you prefer, don’t listen to my advice. When you’ve lost a large amount of money, enough for you to care about, then you might change your mind.
On to what many new investors say is obvious, the lesson on why losing money should be avoided.
Don’t lose money
This might seem to be as obvious an advice you could give. But many don’t understand how important this is.
Losing money is bad. We all know that. But why is it bad?
Because it is hard to make back what you’ve lost.
Many people think about the number value of a loss. That includes seasoned investors. But the key is the percentage. That should be the focus.
Why?
If you go from $100 to $50, you’ve lost $50. That $50 needs a 100% return to become $100 again.
It is simple math. Yet few think about it that way. You shouldn’t think about it as if you have to add $50 to get back to your original sum of money. You should think about the rate of return needed.
If you need a 100% return to get to square one that can take a long time. Given a market return of 10% per year, which is the average for the S&P 500 index, you’d have to “wait” for 10 years.
Making up for lost money takes time. Lots of time. Because of this simple fact, we should avoid losing money to the best of our ability.
You will lose money, and that is a given, but having this idea in mind should lead to better investment decisions. Buying stocks you don’t understand will put you in a bad position. Your chance of losing money is higher than if you used a simple index fund.
I’m beating a dead horse but to hell with it. Most people should use cheap index funds and be done with it. At the very least, they should make up a considerable percentage of your portfolio.
Skill vs Luck
Its a common belief that those who win in investing tend to have more skill. Sounds correct. But does that hold true?
Nope. Because when skills go up so does the importance of luck.
Our markets today are far more complex than 30 years ago. At the same time, the skills of investors have increased. This increase in skill has made the variation in skill amongst investors decrease.
That means that the difference between the absolute best investor and the worst has gotten a lot smaller than it used to be.
Before a superstar investor might have had certain competitive advantages. They often got information before everyone else, leading to an advantage. But today, through technology, those advantages are gone. Information is cheap and easy to come by for everyone.
This leads to an interesting dynamic because it means that the paradox of skill comes into play. To understand this paradox, you need to understand the concept of reversion to the mean. Stated in a simple way, it means that over time, every thing goes back to the mean.
If we say that the mean is 0, that means everyone, eventually, will end up there again. A positive deviation from the mean will in most cases be because of luck, not skill. In a world where the paradox of skill exists, skill becomes more of a “nonfactor”. When everyone is close in competence and knowledge, the significance of luck increases by a lot.
Reversion to the mean gives an important insight to what is probable to happen in the future. Overperformance will turn into underperformance and vice versa.
You might have heard of Morningstar. They sell finical services. Amongst other things they do, they are famous for rating funds. Many people refer to the rating a fund receives from Morningstar as a sort of quality indicator. But should we do that?
We might want to avoid that. Because research shows that revision to the mean is in play. Within three years, 8 out of 10 funds, will have lost their star rating. Yikes.
Other research shows an interesting result. Professional investors are capable of outperforming an index. But the fees kills the gap they’ve built up.
How can you justify your fees when your performance relies on luck? You can’t. Simple as that. You need to “shuffle” the cards so to speak. Make people believe in your ability. Make them think you’re capable of doing something they can’t.
We believe that a fund that has done great will always be great. That isn’t true. As I showed before Morningstar data tells a much different story.
You are likely to hear stories about successful investors. What about investors that underperformed or went belly-up? Do you hear about them? It happens, but is rare. If you hear about a failed in investor, they failed in a spectacular fashion. We focus on the successes.
Why?
There are many reasons. But one I’d like to point out is the survivorship bias. It makes us focus on what we can see and ignore what we can’t see. This can create problems.
We love success stories. They make us dream. Giving us hope. One day, we might strike it rich. We never think about those who didn’t make it.
There is a story from the world wars that exemplifies the survivorship bias in a great way. During world war 1 & 2 the Allies wanted to increase the punishment their planes could take. They did this by studying the planes after battles.
They wanted to know where the plane was hit. If they knew this, they could reinforce those spots. By doing that, it was their belief that their planes would be more durable.
But there was a flaw in their thinking.
Planes that made it back wasn’t the problem. Their focus should had been on those that didn’t make it.
It’s easy to focus on the winners. That is survivorship bias. While the winners tells a story, losers have stories of their own. But we often ignore them. We want the glitz and glamour. Nobody wants to hear about they guy who offed himself after losing it all.
That is an oversimplification of the survivorship bias. But its good enough for my purposes.
Why did I bring that up?
Simple, that great fund you’re looking at isn’t unique. There were others with the same strategies, skill and technology but who failed.
You focus on the winner, ignoring the losers. That is a dangerous game to play.
Based upon the thinking around retiring to the mean gives us, we can make a couple of conclusions.
Over-performers will do worse, under-performers will do better. Both will go towards the mean. Luck disappears for the winners. It’s found by the losers. Take this for what you will. But keep this in mind, nobody can win forever. Nobody can lose forever. It’s a game with skill, but a whole lot of luck too.
Invest in what you understand
Buying something you don’t understand is stupid. You want to avoid being stupid. So don’t be.
From time to time, there are certain assets that become hot. Everyone wants in. Your friend, the stupid one because who else, makes bank.
Take crypto. It’s had a crazy good run. Look at Bitcoin. Fuck me, that became a rocket ship. That kind of performance gets attention.
FOMO grows until outsiders can’t take it. They need to get in on the action.
That’s why we see a lot of new money going into the crypto markets. People want to find the new thing in crypto. It’s understandable. We all want to make money.
But that is a losing strategy. Lots of them lacked the knowledge needed. That made them unable to make informed decisions.
Bitcoin, Ethereum, or Cardano. What’s the difference between them? What should you look at when evaluating crypto? Will BTC reign supreme in the future despite it’s drawbacks?
My belief is that many can’t answer these types of questions. Especially in crypto that is in it’s infancy.
That will lead to costly mistakes. We want to avoid that. When mistakes do happen, we need to be able to analyze and get the why. That requires basic knowledge.
But this goes beyond exotic assets such as crypto. A lot of people buy stock based on pure speculation. Look at the valuation of Tesla. Is it reasonable? Will they be able to deliver on it? Do you believe the average investor holding Tesla could answer that question?
This is why people should buy index funds and be done with it. I’m not a sophisticated investor. I know my limits. In investing, from my experience, being humble is a trait that gets rewarded.
Most of my wealth is in simple, low-cost index funds. That is what I recommend to those asking for advice. A bit boring I’ll admit but that’s okay.
Lots of people think investing can make you rich. But can it? Lets look at that next.
Getting rich
A lot of people believe you can get rich by investing. That belief is most likely wrong.
Those individuals we all know about, the Warren Buffets of the world, did become rich by investing. But he dedicated his life to investing. Something a lot of us aren’t willing to do. Nor can we assume we would be as good.
Most investors that are known by the public got rich by other means than investing.
Sure, they might have made their wealth in the investing game, but not from investing itself. They run hedge funds, top investment bankers, or something akin to that. While they invest, a majority of their wealth will come from their clients or job, not investments.
I’m telling you this so that you can adjust your expectations. If you want to become filthy rich, investing in an index fund will be a major letdown. To get filthy rich, you need a high-paying job (think top politician, lawyer, banker, CEO). Another route is creating your fortune from entrepreneurial pursuits.
Buying index funds is a great option for most. I want to live a comfortable life, especially the older I get. Worrying about money isn’t something I want to do.
Investing in index funds will never make me insanely wealthy. But it will, with a high probability, make it so that I can live a decent life.
Will I be able to buy a Bugatti? No. But money won’t be a problem. I will be able to indulge in good wine, take trips, buy what I want and share the wealth with those around me.
In other words. I won’t be filthy rich, but I’ll be rich enough.
Closing
You should buy an index fund. Make it a broad one. Invest an amount works for you. Keep buying and ignore the market. Use the buy and hold strategy. A small percentage can go to risky assets. Be it for investment or speculation.
Keep doing this until retirement is a couple of years away. Then you can start being a bit defensive. Trade risky assets for safer ones.
Nothing is guaranteed, this strategy might turn out shit. But history tends to repeat. And history has been kind to this strategy. I believe the above option is the best for most people.
Happy investing.