All About Investing, Simplified

You have money to invest. What do you do? There exist a bewildering array of jargon-ey investment options. The first thing to know: over the long-term, stocks outperform all other investments. Second, you can’t beat the market. If you don’t believe me, feel free to try.

Why choose stocks over the long-term?

Investing is a tradeoff between risk and return. Risk is the chance you will lose your money. Return is how much profit you make. The higher the risk you take, the higher your returns can be. Thus, returns are a reward for your willingness to take risks.

Stocks are the riskiest investments. The day-to-day movements of the stock market can make little sense as stocks lose or gain value. Thus, stocks are volatile and risky. Here’s the kicker. Over the long-term, stocks aren’t risky at all. Look at the graph below of the Dow Jones Index.

As you can see, over the long run, stocks always go up. After 2000, the stock market looks very volatile. Before 2000, it looks relatively smooth. That’s because, over the long-term, stocks gain so much that any older volatility is so small in comparison that it gets smoothed out. Conversely, newer volatility looks huge and frightening. But, if you stick it out, this volatility will diminish in the face of your returns over the long term. This is why stocks are your best bet over the long-term.

What if I want short term gains?

Then you should probably get a degree in finance, become a stock trader, gamble, found a startup. Don’t all of those sounds incredibly hard and/or risky? There are no shortcuts to money or gains. As you already know. Because otherwise you’d be rich already. Why is this so? Because there are lots of incredibly smart people out there who have been studying how to make money their entire lives. So, to beat them, you need to work harder than them, or take more risks than them, or some combination of both. Your best bet is long-term investing. This is as much a guide to not losing money as it is a guide to making money.

What if I can only invest short-term?

Invest in bonds. Your returns are low, but your money is relatively safe. There are bond funds that will do this for you.

I get it! How do I invest in stocks?

People typically get interested in stocks when the market starts running up. The dotcom bubble for instance. They invest in stocks they don’t understand. The first rule is, don’t invest in something you don’t understand. Use mutual funds, which do the investing for you, for a fee. A typical mutual fund fee is between 0.1% to 2% of your money a year. This is important! It means your return is decreased by the percentage of your fee. If your fund gives you a 10% return, with a 2% fee, then your actual return is 10%-2% = 8%.

How do I get a low fee mutual fund?!

Glad you asked! The lowest fee funds are index funds. What’s an index fund? An index fund simply tracks an index. So a Dow Jones index fund would track the Dow Jones. If the Dow goes up, you make money. If the Dow goes down, you lose money. Tracking an index is simple with computers, which is why index funds have low fees.

Okay, so how do I know when to invest? Doesn’t the market go up and down?

The great thing about investing long-term is you don’t have to worry about short-term fluctuations, since stocks always go up in the long run. I wouldn’t advise trying to time the market. Much smarter people have tried and failed. Having said that, it does pay to not invest in a stock market at the height of a bubble, because it could be many years before you make your money back.

Right! Can I get a feel of what my returns would be?

Some quick perspective before we calculate returns. Your first goal in a stock market is to not lose money. It’s incredibly easy to lose money investing. If you ask me, investing is worse than gambling. At the least, in gambling you know you have some fixed chance of winning. In investing, you’re up against the Soros-es, Blackstones, and the Greenlight Capitals of the world. It’s easy to lose. As I said, this is as much a guide to not losing money as it is a guide to making money.

The graph below shows you everything you need to know. There are 4 lines, for 1 year, 5 year, 10 year, and 20 year returns. The 1 year line shows your percentage return if you had invested money a year ago. The 5 year line shows your percentage return if you had invested money 5 years ago, and so on. For example, take the 20 year line. In 2010, it shows that if you invested money 20 years ago, i.e. in 1990, your return would be just shy of 10%. The graph shows that if invest money over the long-term, say 5 years or more, you can blindly put money into stocks and you will never lose money.

Yes! I’m saying you can make money off stocks even if you know nothing! Take a look.

This doesn’t sound right? How does this work?

The stock market is cyclical. Over the short-term, there are a million different factors that drive the market, and it makes little sense. Over the long-term, the market goes up more than it goes down. That’s what these graphs show. Ofcourse, no one can predict the future, but this is what the past tells us. Because the stock market is cyclical, it’s important not to sell at the first sign of bad times but to hang in there. Remember, you’re in for the long run.

Cool. Any tips?

If you’re saving money for a downpayment for a house or other payment, keep that money in cash well in advance of when you need it. That’s because the best time to buy a house is when prices drop in a recession. But! Stocks completely tank in a recession. So you shouldn’t rely on stocks to fund big purchases. Move your money into cash so that you have it when you need it.

Remember that inflation cuts into your returns. You need to subtract inflation from your return to get your real return.

Phew. Can I haz summary?

  • Real Return = Return – Inflation – Fees if any.
  • Invest in index funds for the long-term.
  • Don’t try to time the market.
  • Don’t invest in something you don’t understand.
  • Diversification is useful, if you know what you’re doing.
  • If you need large amounts of money, keep that money in cash, don’t invest it.
  • For short-term investing, use bonds.

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