Today I give you guys five tips about investing in the stock market!
As you know, I managed huge portfolios in the past — many billions. I managed stocks, options on everything: indices, stocks, and bonds; also futures, commercial paper, portfolio swaps, variance swaps, a lot of different kind of financial products. I do not want to brag. If you knew me personally, you would know I am more a reserved kind of guy. However, on Internet, there is a lot of people that talk about finance, and how would you know that I know exactly what I am talking about if I did not tell you about my experience.
I am sharing with you my professional investor’s experience. I want you to succeed in your investments in the stock markets.
Tip #1: Start investing today!
If you can find Doc’s Brown DeLorean, you know from the movie “Back to the Future,” go back in time and start investing yesterday, it is even better!
Why? Because time is your ally, through compound interest. According to Einstein: “Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t… pays it.” I, for one, prefer to earn it, and I guess you guys prefer to receive it too, else you would not be here.
When we say the S&P 500 rose by x percent last year, and it grew y percent this year, we do not mean it grew overall x plus y percent over two years! It is wrong. It is not an addition. Instead, it is multiplication.
Let’s take an example: an index rose by 15 percent last year, it grew by another 20 percent this year. You invested in this index. Your investment grew not by 35%, but by 38%.
How I did it? You take the percentage figure, and you write it in its decimal form. Fifteen percent is 0.15, and twenty percent is 0.2. You divide the percentage figure by 100. Then you add to each of the number 1. 0.15 becomes 1.15, and 0.2 becomes 1.2. And now is where the magic happens: you multiply 1.15 and 1.2 together, and you get 1.38. You apply the steps in reverse order: subtract 1, you get 0.38, multiply by 100, and voila: 38%.
It is simple.
What does it mean for you? When the market grows, it is growing faster and faster. Each dollar saved today will grow with time at an increasing rate. It is what we call exponential growth. Don’t be afraid of the mathematical term; here it is your best friend!
Moreover, it is not yet the whole story. When you invest in stocks or an index, you get dividends! And when you reinvest your them, it helps.
Let’s play a simple game. The S&P 500 rose by about 115 percent since January 2000, even if we had two major market meltdowns, the dot-com bubble and the financial collapse of 2008. If you had invested in the S&P in January 2000, not added more money since, but only keep reinvesting your dividends, can you guess by how much your investment would have grown? It is more than 115 percent, obviously, maybe 125, or 150, it surely cannot be more than 175 percent? Can you guess?
The correct answer is more than 210 percent! Just by reinvesting your dividends, your investment is now 86% percent bigger, than by just looking at the index performance. Isn’t it nice?
Tip #2: Be consistent
Right now, the market seems to be high. And it looks reasonable to wait for a correction, to have better timing. Who does not want to buy at the bottom, and sell at the top? The truth is that no one can do that. No one! At least not every time.
However, we know that in the long run, stocks are doing well, very well. Since nobody can always have a perfect market timing, what should you do guys?
As investors, you should invest in the market a portion of your paycheck every paycheck, let’s say $100 or $200, or more, it depends on what you can save for your long term investments.
Regularity is the key.
By investing regularly you will sometimes buy at the peak of the market, but also sometimes you will buy at the bottom. In the long run, the average price you paid for your investment will be lower than the market price in the future.
The game is not the same if you have a lot of money to invest one shot, and no more. Let’s say you have $10,000,000 to invest right now. First good for you. Secondly, even if in the long run, the stock market is an excellent investment, you have to ask yourself if you want to invest in stocks at the current price. Don’t say, a guy on the Internet told me that I had to invest in stocks, the market went down 10% and now I lost a million dollars. As always, everything I say on my website is my opinion and not an advice of any kind. You should always use your common sense, and talk to a professional about your unique objectives and needs, especially on investment, tax, and legal matters.
One more word about consistency, guys, it’s excellent to invest any amount you can in the stock market. However, in the short term, stocks may perform poorly, and if you need to sell, you may lose money. You have to keep it in mind. So invest in the stock market money you will not need in the short term. It is essential. There are outstanding saving accounts right now, use them for your emergency fund, and the cash you will need in the next year or two.
The best way to think about money in the stock market is, when you put $100 in an index fund, consider it gone for the next five to eight years. It doesn’t mean that you will not be able to get it back in the short term with a substantial profit. Usually, it will be the case. But bad things happen also, and you need to take it into account. If the market goes down, you may have to wait to recover your money plus a profit.
Tip #3: Invest in a broad index
Unless you know what you are doing, and do thorough research about the stocks you pick, direct the lion share of your investments in a large, well-diversified index fund or ETF — something like the S&P 500 in the U.S.
You will first avoid a lot of fees. For example, Fidelity has the Fidelity ZERO Total Market Index Fund. As its name suggests, it has no fees, zero! And no fees means more money for you guys in the end. It is not an endorsement, and Fidelity does not sponsor this post, I just thought it is good to know, and I had to tell you about it. There is a lot more funds and ETFs on broad indices, choose the one you like!
Investing in a fund that follows the S&P 500 gives you an exposure to the growth of the whole economy. You don’t have to choose what stock will win, and which one will fail. Overall your investment will perform very well in the long run. It is called diversification, and a broad index like the S&P 500 is giving you that.
Now, think about the following question: Do you need to invest in different indices, let’s say, funds on both the S&P 500 and the Russel 1000. Or maybe between distinct geographic areas, U.S. and Europe for example.
What do you think?
You can; however, the diversification benefit may not be very significant because stock markets are correlated. It means that in general, they tend to move in the same direction at the same time. If tomorrow, the U.S. economy enters in an economic slowdown, I do not see how Europe, with debt-crippled countries, can do anything but fall into a recession also.
So do not overthink diversification.
Studies show that to get the most benefit of diversification; you need to have around 30 stocks, then S&P 500, with 500 different company’s shares is good enough, I think.
One more last thing about diversification, the key is to have assets that do not move in the same direction together. So if you really want to achieve greater diversification, then you have to include in your portfolio bonds and commodities, which are whole new asset classes themselves. It is not in the scope of this video, which is long enough. If you want guys I can talk about that in another video, let me know in the comments below.
Tip #4: don’t be emotional, and do not fall in love with your stocks
Yes you can fall in love with the stocks you own or feel a deep hatred for others. Will you be surprised if I told you it is a bad, bad thing?
The problem is that when it happens, you stop thinking clearly, you react emotionally, and it leads to disasters.
It happens to everybody, even I have to fight it for my personal investments. I lost one time more than $20,000 because I was sure the market was wrong. I felt in love with that stock. And I kept buying it. Until one day, I woke up, and I sold everything and did something else. Even I, aware of this pitfall, was lured into it, once. As they say, sometimes you win, sometimes you learn. I learned to be more watchful about my own emotions when I invest my own money.
It is less likely to occur for a fund manager. It is one significant advantage to have your money in a fund. As a professional, in the funds I managed, I had rules to follow, guidelines, risk limits. All that environment makes the professional investment so superior to the average individual investor.
Guys, tips #2 and #3 give you the edge to be like an investment professional. If you regularly invest, regardless of market conditions, and chiefly in a fund following a broad index, you create for yourselves this cold, professional environment that will make you win.
I know it is fun to pick stocks, buy and sell quickly. So I do it, and you can do it too. But maybe just on a small portion of your portfolio, your core investment should be in indices, unless you know what you are doing. But always keep your emotions in check. If you start telling to yourself I will sell my S&P 500 because I need to buy more of this falling stock, to lower my average price per share, let me say this: it is probably a bad idea, like trying to catch a falling knife. And maybe it is time to get out and rethink the investment.
Tip #5: do not overtrade
What is the best way to destroy your portfolio? Overtrading is probably the one. Each time you trade individual stocks, you pay trading fees. Two times! When you buy and when you sell. It is not an issue when you let your investments appreciate enough to render the costs of trading insignificant in comparison to your profit. However, the more frequently you trade, the fees take a bigger bite at your earnings. Worst if you have a loss, the trading costs make it even worse.
As you know, time is your ally, when you trade too frequently then you switch the natural growth of the stock market for random chance. Which, when you add fees, makes you less likely to make money.
Sure there are day traders that make a living by trading all day long. But for one successful day trader, how many small investors lose all their money.
We, humans, tend to be overconfident. Since you are smart and know about overconfidence, do not fall for this fallacy. Invest regularly, in a broad index, and you will make a lot of money. With experience, you will be able to expand your investment horizon with the same success!
So to conclude, my five tips as a professional investor are:
- Start investing today, there is no time to lose.
- Be consistent, invest regularly.
- Invest in a fund or an ETF on a broad, well-diversified index, like the S&P 500. It should be the core of your investment, at least until you get more experience choosing which stocks to buy or sell.
- Don’t be emotional, do not fall in love or hate your stocks. Try to be as rational as possible, and base your decisions on facts!
- Do not overtrade!
Let me know what you think about those tips in the comments below. Do not hesitate to share your tips also!