If you are new to investing and the stock market in general, I know how overwhelming it all can feel and most people’s reaction when in fear is to freeze and do nothing. Not a good strategy, trust me.
Luckily, there is a solution to this problem, in the form of a short and very practical book called The Simple Path To Wealth by J.L.Collins.
It will empower you by giving you control over your investments while providing you with an extremely simple strategy... and the best part is that you don’t need any prior knowledge for this to work. It may very well be the only resource you ever need to read when it comes to investing.
If you can’t or don’t want to buy the book, read Collins’ Stock Series on his blog.
I really recommend reading the book and taking action as soon as possible. One extremely important concept in investing is compounding interests. Albert Einstein is reputed to have said this:
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it.”
The point is that the earlier you invest, the more you’ll end up with and the difference of just a few years can be huge. So don’t wait.
As an intro to the book or as a memo if you have already read it, here are a few concepts described in the book that you’ll want to keep in mind when you start investing.
How To Invest
1/ Open a Brokerage Account
If you are in the US, open an account with Vanguard. If you can’t do that, open an account with any other broker but make sure to choose one that does not charge any fees. The tiniest of fees add up over time and will cost you a lot in the long term. Don’t do that. Banks and brokers have enough money, keep yours for yourself or, if you really want to get rid of your cash, give it to someone in need.
2/ Buy The Market
You don’t want to be stock picking if you don’t know what you’re doing. Don’t listen to the financial media, don’t overthink it. You’ll read in the book all the arguments in favor of investing in a total stock market index fund, the main argument being that there is almost zero chance you can beat the market’s returns by stock picking - unless your last name is Buffet, but let’s be honest, it’s not. Don’t waste time and your hard earned money, aim for the market’s returns.
Index funds to buy (as suggested in the book) - pick one:
- Vanguard’s VTSMX if you have less than $3,000 to invest (link)
- Vanguard’s VTSAX if you have at least $3,000 to invest (link)
- Vanguard’s VTI if you prefer an ETF or can’t access the first 2 options (link)
Those funds will give you access to the american stock market and it's returns. That’s what Collins recommends going for in his book. Now if you’ve read the news and think (like me) that there may be some value in investing outside the US, two points:
- Collins says that most large US companies will already give you that international exposure (because they have branches worldwide) so there’s no point;
- If you still want to diversify regionally and/or on the currency, look for other ETFs or mutual funds that have a total stock market exposure that is not just US stocks but worldwide.
If you can’t access the funds mentioned above or if you live in Europe and have a tax incentive for investing in European funds, you could look at options like ISIN: FR0011869353 or LU1681043599
Note: EWLD has a TER of 0.45% but does not distribute any dividends (they are re-invested for you) which could be positive for taxes.
Both are covering a worldwide total stock market (large cap only) and ‘should’ be eligible for your PEA if you reside in France (you should verify). I would personally go with CW8 if I was in France because of the lower TER since there is no tax on dividends in a PEA. If I was in Belgium however, I would go with EWLD because there is no PEA in Belgium and dividends are taxed. Since this strategy is a long term investment you’d want to reinvest the dividends anyways. What's great for Belgians is that they are not taxed on capital gains, so this is a tax-free strategy. For residents of other countries, try to find a (legal) way to pay as little tax as possible while still being exposed to the entire worldwide stock market.
Most important of all, when selecting a fund, be sure to choose one with a low TER (total expense ratio) because as for other fees, they heavily impact your total return (and that’s why Vanguard funds are recommended when possible - VTSAX has for example an TER of 0.04% and VTI 0.03%!)
3/ Optimise For Taxes
Taxes, like fees, are very bad for your return. Make sure you optimise and leverage all available options, like IRAs in the US and a PEA in France...
4/ Sit Back And Relax
That’s basically it. In theory, you should start with point n°3 because it might impact the type of brokerage account you open, and if you’re not sure how to optimize for taxes, speak with an expert in your country or region. But the point is to simply find a cheap total stock market fund and invest in it 100% of your investments, every month. Done.
Allocation & Risk Mitigation
Of course, you could go one step further, but it all depends on the stage of your life you are currently in. Collins describes two stages: Accumulation & Preservation.
Accumulation is when you work and have an income.
Preservation is when you live off of your investments (retirement or sabbatical).
Your strategy and portfolio should be slightly different depending on which stage you are in or you will be in the next few years (start shifting to the Preservation strategy a few years before retiring for a smoother ride).
Invest in 100% stocks or 90% stocks 10% bonds (Collins says your returns could be slightly better with 90/10, but he also says the difference is not worth the trouble); The advantage of holding 100% stocks is that you don't have to rebalance your portfolio, the disadvantage is that you can't sell bonds to buy stocks when the stocks are on sale (see "when to sell bonds & buy stocks" below).
Split your investments between stocks and bonds, anywhere between 80/20 and 60/40;
Why? Bonds are supposed to be less volatile than stocks and are even sometimes considered inversely correlated to stocks (i.e. going in the other direction: when the stock goes down, bonds go up - or at least they don’t go down as much). That is what Collins calls “smoothing the ride”.
The main idea is that when in Accumulation, you should invest in stocks every month, whether the market is up or down. That way, you get to buy the stocks when they are discounted (when the market is down). However, when you are in Preservation mode, you can sell some bonds to buy those cheap stocks when the market is down. That’s how you make the best returns (when the market goes back up - notice that it’s not “if”, but “when” the market goes up - you will be able to catch a piece of that growth).
When to sell bonds & buy stocks?
There should be two different triggers: 1/ the stock market crashes and 2/ your rebalancing anniversary date.
Collins recommends to sell bonds and buy stocks when stocks are down 20%. Don’t bother too much otherwise.
Also, you should pick a date in your calendar each year to rebalance your portfolio. This means sell and buy either asset class to make sure your portfolio has the asset allocation that you intended (ex: 80% stocks and 20%bonds). It is proven that rebalancing gives you the best returns because it forces you to sell high and buy low. Again, make sure your broker does not charge any transaction fees because that will hurt your overall return since you’ll be making a few transactions over the years.
Finally, there is an argument against holding Bonds in 2020 as explained in this article about Ray Dalio, the founder of the largest hedge fund in the world):
If you are in Preservation mode and agree with Ray, you may want to diversify differently than bonds, by maybe buying Chinese bonds, gold, silver… or cryptocurrencies. Either way, you should look for an asset class that is as decorrelated from the stock market as possible and that you can sell quickly when needed (i.e. an asset class that is liquid, which means avoiding real estate for example).
A Few More Things To Remember
1/ Investing Is For The Long Term
If you are investing, you should be have a long term perspective. If you are in the market for day trading, gambling or speculating, then none of this advice will work for you and you’re “on your own” here. Investing in the stock market can only work reliably by taking the long term view (because of short term volatility). If you intend to use your funds soon, in a few months or years, try to avoid the volatility and smoothen the ride as much as possible.
2/ Don’t Ever Panic
You should fully expect the stock to go up and down. And during your long term investment period you’ll probably have to go through 3, 4 or 5 big crashes, the media will be acting as if it is the end of the world and people will tell you to sell, sell, sell. The number one reason why people lose money in the stock market is because they sell during crashes. Don’t sell unless you absolutely need the money. A study has shown that people who have made the most money on the stock market are dead people - because they don’t panic and sell when it goes down. The single most important factor defining your success in the stock market is your ability to weather the storms with equanimity. Stick to your plan, don’t listen to the media.
3/ Don’t Try To Time The Market
We’re all tempted to sell when we think a crash is coming, before the downturn. We think we’ll be able to preserve our net worth by doing so and go back in the market when it’s at its lowest. Well, the truth is that no one is able to do that reliably. More often than not, you’ll be timing it wrong, sell too early and miss great gains or go back in too late and buy higher than you sold (if at all). It is proven that missing only a few of the biggest growth days in the market has terrible consequences for your overall returns.
4/ You Don’t Need Anyone Else's Help
This is critically important. Money managers will eat your lunch. Don’t let them. Their fees will destroy your returns and your investments will end-up performing a lot worse than the market, even if their gross returns (before tax and fees) are higher than the market’s. Remember that it was proven that very few people can consistently beat the market.
If there is one person you should consult, it should be a tax expert, someone that you’ll see (and pay) once and that can help you optimize your accounts so you pay as little tax as possible. For anything else, be your own asset manager. Eat your own lunch.
5/ Keep It Simple
You will be tempted to diversify or invest in single stocks and make bets at different times. Just remember that any one stock can go to zero. In other words, know the risks and how your decisions may impact your portfolio’s returns. By keeping things simple, you declutter your investing mind and can spend more time doing other things. We have seen that the less you think about it the better. Set it and forget it is the best approach.
6/ The Stock Market Always Goes Up
Image Source: https://www.macrotrends.net/2324/sp-500-historical-chart-data
Sure, there is volatility and, on any given day, week, month or year, your portfolio can go down. But in the long run, there is little risk in the market. If you can muster the guts to believe in that when the market goes down, you have won the money game.
The stock market is an amazing tool to build wealth. The anti-capitalists will hate you for leveraging it, but what everyone needs to understand is that the stock market is the most democratic and egalitarian tool of all. Anyone can own a piece of the economy. The Internet and fintechs have made it extremely easy and cheap - even free. There is no good reason not to own stocks if you are able to generate somewhat of a surplus.
So why is there such a huge portion of the population not investing in the stock market?
I can think of a few reasons, the main one being fear. Fear of losing all your hard earned money and distrust in the financial industry. Most of it is probably due to the lack of understanding of what the stock market is and how it works. That’s why I warmly recommend J.L. Collins’ book. It’s a great and simple device against misinformation and will likely turn fear into positive, and hopefully immediate, action.
Disclaimer: The information above is provided for information only, it is the reflection of the author's opinion and does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell, or otherwise transact in any investment including any products or services or an invitation, offer or solicitation to engage in any investment activity. The author invites you to do your own research and come to your own conclusions.