Stock market investing (wisely) is actually not that hard.
There are a lot of different ways to invest your money.
You can invest in real estate, in venture capital enterprises, in horse races, in savings accounts…or in the stock market. Some of these options count as investing. And some count as speculating.
A Physician’s Guide to Real Estate Investing
Before my financial education, investing in the stock market basically seemed like investing (AKA gambling) in a horse race. It felt random, risky, and super complicated. Basically, I assumed that the being successful in the stock market required luck, a crystal ball, or some other wisdom that I did not possess. I thought that stock investing was speculation.
Like many of my assumptions about personal finance, I was wrong
Admittedly, my opinion of stock market investing was largely formed based on opinions of others who had invested inappropriately and got burned as well as by the just incredible amount of conflicting and loud information out there on the topic.
It seems every “financial guru” was just screaming that they were right about this stock or that. And some other one was yelling the opposite thing and that the other guy was wrong. It was basically my fantasy football league arguing over the merits of drafting a wide receiver first overall. Uninformed and wrong 80% of the time. (We’ll get back to that 80% later…)
All of the cacophony and confusion led me to the conclusion that this was just too risky and complicated, and I ought to hire someone to figure this out for me or maybe not even invest this way. If you’re read this blog, you won’t be surprised that this was the wrong approach.
By learning some basic concepts, I went from clueless to managing my own investments in a month. I then took my net worth from -$500K to +$410K in 1 year. You can too.
So, let’s learn about investing, not speculating, in the stock market
First, a few simplified definitions:
A stock is a part ownership in a company. You buy one share and you become an owner. Each share has a price tag when you buy it that changes based on various and, at times, arbitrary factors as they are traded in the stock market. If the price goes up, good for you, you just made money. If it goes down…not so lucky.
A bond is basically an IOU from the government, a corporation, or other entity. You give them money and they promise you to give that amount of money back with a fixed interest rate at a later date (called the maturity of the bond, like 5 years, 7 years, or whatever).
A mutual fund is a collection of stocks that some financial wizard puts together that she or he thinks will perform very well i.e. the value will overall trend upward.
An index fund is a collection of stocks strategically picked to mirror some index marker of the overall stock market. For instance, the S&P 500 is an index with a collection of stocks thought to give a good sense of the overall market. (Is the market going up or down?, etc.) An index fund will mirror the movement of the index that it is based on.
Ok, now that we have that out of the way, let’s get into our stock market investing strategy
When you buy a company’s stock, you are saying that you believe in that company’s success. If you are right, like with Apple, you make a lot of money. If you are wrong, like Enron, you lose all of your money.
Picking the right company, or horse, can be difficult even for the “experts.”
How difficult? Well, as I’ll go more into later on, research shows that even “experts” underperform the overall stock market 80% of the time when they try to actively invest by timing the markets and picking stocks or funds.
Don’t just buy one stock, buy them all!
When you buy the whole U.S. stock market, you are saying that you believe in the overall ingenuity and innovation of humankind and the U.S. economy
So if you make this bet and you are right, you make money. If you are wrong, the economy and civilization as we know it collapses. Your portfolio will be the last thing on your mind. Everything to gain and nothing to lose.
Betting on the whole stock market is a much safer bet
Let’s do an experiment
Take out your iPhone or Android or whatever phone you have.
Go to the stock market app and look up the S&P 500.
It will default show you the fluctuations over a time period of one day. The ups and downs will seem random. And they are.
Now change the time period to one month. Still pretty random.
Next, change to one year. Then five years. Then twenty years. And finally, all-time.
A trend is shaping up
As you can see, over the long term, the overall stock market has always gone up. If you put money in the overall stock market at any point in history and just did nothing and kept it there for 20 years, you would have made a lot of money. This is largely what you are doing by investing in broadly diversified index funds.
This also underscores the importance of only investing money that you do not need in the short term.
Money you may need in the next 5 or less years should be saved like an emergency fund. Here’s a guide to show you how to safely do that.
Anyway, back to stock market investing via index funds
For example, the brokerage Vanguard (my favorite for its low costs and ease of use) has an index fund of every stock in the entire U.S. stock market. Buy that index fund and you own the next Enron, but you also own the next Apple. And everything in between. You will be investing in the innovation and entrepreneurial spirit of humankind.
Now, you may want to also bet on the global economy in addition to the U.S. economy. So you can buy a broadly diversified international stock index fund.
What about index funds for things other than stocks?
Bond index funds
Hmmm…still feeling like you’re taking on too much risk by putting all of your savings into stocks, even though you’re not planning to need it for 15-20 years. No problem.
You can buy a bond index fund just the same way as a stock index fund. The performance of bonds does not correlate with the performance of stocks, so you are now diversifying.
Real estate “index funds”
Lastly, you’ve heard that real estate is a smart investment but aren’t ready to buy a rental property. We still have you covered. You buy a REIT (Real Estate Investment Trust) index fund. This is essentially a fund representing ownership in a collection of real estate investments. REITs behave differently than stocks AND bonds, so you are even more diversified.
I put “index funds” in quotes here because a REIT is not exactly nor technically an index fund. But it serves a similar purpose and acts in a similar way.
Let’s review these stock market investing tips
You’ve decided that you would like to invest in a total U.S. stock index fund, a total international stock index fund, a bond index fund, and a REIT index fund.
How do you split things up?
There are a lot of thoughts on this topic and not many ways that you can go wrong.
Some people say that your age rounded down to the nearest 10 is the percent that you should have in bonds. I’m 32 so that would be 30% bonds.
However, I know that I will not need the money that I am investing for 15-20 years or more so I’m more aggressive. Let’s say I do 10% bonds.
The rest, you can split up as you wish.
I’ll give you an example of a totally reasonable split (AKA asset allocation):
40% Total U.S. Stock Index Fund
40% Total International Stock Index Fund
10% REIT Index Fund
10% U.S. Bond Fund
Well, now is the easy part. Take the total money that you are going to invest and multiply it by each percentage. That is equal to the amount that you will put into each fund.
After you do that, just sit and do nothing (except re-balance once a year, which I cover in depth here).
You are prudent and only invested money that you will not need for 15-20 years. If the market goes up, down, or sideways tomorrow or next month or next year, you don’t care. You don’t care what the talking heads on TV or in the newspaper say.
Over the long term, you know that your investments will rise because you are smart and bet on the ingenuity of humankind rather than try to stock pick or time the market, which no one in history has been able to do reliably.
In fact, by managing your portfolio this way (passively), statistics show that you have a portfolio that is better than 80% of people in any given year who try to actively “beat the market.”
Can you believe that people pay more (in advisor fees, transaction fees, and taxes) for active investment management?
Pay more to do worse. That’s a losing hand.
A final warning about stock market investing…Keep. It. Simple. Stupid.
Finance parallels medicine in a lot of ways.
In medicine, like in finance, you will find people are complexity things. And people who simplify things.
My experience has been that the people who can break things down to their most important parts and distill it in an understandable and reproducible way have the best handle on a topic. Whatever that topic may be. Those are simplifiers.
Also in my experience, people who complexity things usually (A) don’t actually understand it that well or (B) are trying to make it seem so difficult for some sort of personal gain or to deter others from trying.
So, I made a decision long ago to always seek out simplifiers and not complexifiers in medicine
When I started my financial education, I did the same thing. And I strongly recommend that you do the same thing as well.
Achieving financial freedom is not necessarily hard. The formula is quite simple. Follow the simple principles above and you will be successful.
Put bluntly, Keep It Simple Stupid!
And remember, when you make a lot of money, people will always show up trying to separate you from your money.
If someone seems to be making an investment or insurance or asset protection strategy too complex, think to yourself, “Do they actually understand what they are trying to explain to me? And, what do they have to gain from this?”
Want a simple recipe for financial success?
You may also find this post particularly helpful if you are anything like me… Help! I’m a High Income Earner But Scared to Invest!
What do you think? Do you manage your investments actively or passively? Have you ever beat the market? If you’ve never managed your own investments, do you think you could do this? If you think you can beat the market, make a guess about what it will do over the next week and check if you are right. Comment below!
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