There seems to be a contradiction in what the “experts” tell us about investing in the stock market. I’ve heard investment professionals who have said the process is simple and that individuals just make it too complicated. On the other end of the spectrum, I’ve heard that investing is extremely difficult and only those that put in extraordinary amounts of time and effort will be able to be successful. I’ve also heard the in-between argument, that it’s not too difficult but you still have to “do your homework.” My belief is that they’re all right. However, investing really is only as complicated as you want to make it.
The concept of investing itself is very simple. Investing is foregoing money now to obtain more money in the future; more, meaning, after taxes and inflation are considered. When it comes to stocks, an investor is buying a slice, or fractional ownership, of something, usually a business. One can either buy a slice of a company, a sector, or a slice of a market index. For instance, you can invest in General Electric (a company), an exchange-traded fund that tracks clean energy (a sector), or an S&P 500 index fund that gives you the exact return of the S&P 500 (a market index). Each of these provide various levels of challenges and time commitments; hence, why investing is only as complicated as you want to make it. Moving from an individual company to a market index is, generally, going from the most to the least complicated. (There are other variations of these forms of investing, such as investing in mutual funds, that will be covered in a separate post).
Let’s start with the least complicated: the market index. There are many market indices to choose from, the NASDAQ, S&P 500, Dow Jones Industrial Average, Willshire 5000, to name just a few. If you’re going to go this route you should at least study the basics of market index investing, such as fee structure and how to buy into an index fund, be familiar with the makeup of each of these indices, and know the benefits of dollar-cost averaging and tax-deferred accounts (such as a Roth IRA). Then just decide which market you’d like to buy into. This is all the leg work you have to do on your own. Then, after learning about index funds and what they’re all about, you can basically take a “set it and forget it“ mentality. This is why investing in index funds is called passive investing. Set up a tax-deferred account for automatic disbursement into an index fund with a small percentage of each paycheck and every year or so you can check on it just to make sure your money’s still there. By the time you’re ready to retire you should have a pretty nice nest egg. For example, the S&P 500 has returned around 9.4% annually, from 1965-2010, with dividends reinvested. $100 invested in a Roth IRA in the S&P 500 at the start of 1965 without any annual contributions would have grown to nearly $5700 at this rate. If you started with the same $100 and contributed $100 each year, it would have grown to nearly $71,000 (fees are usually nearly negligible for index funds). In my opinion, index investing is the best way for the majority of people to invest because all the complexity is taken out of the process.
Next, let’s look at ETFs, or exchange-traded funds. These are baskets of securities that track the ups and downs of various markets or sectors. The ETF market has grown over the years and gives an individual investor nearly every opportunity to invest in whatever market he or she wants. There are index fund ETFs for nearly every market index. For instance, the ETF with ticker symbol SPY tracks the S&P 500. If you want to invest in gold, there’s a gold ETF, symbol GLD. Sick of rising gas prices? Invest in an oil ETF, symbol OIL. Or, how about a double oil ETF that goes up or down at twice the rate of oil? There’s that too, symbol UCO. However, be careful to look at the fee structures of these as many can be costly. ETFs are considered more complicated than index funds because, for one, they trade the way stocks do. Also, there are many more options. If you want to invest in an agriculture ETF, for instance, you really need to know the ins-and-outs of the agriculture market. Mix that agriculture ETF with a gold ETF and now you have to track and learn about both markets. Plus, you can’t just have a set-it and forget-it mentality with all ETFs, it really depends on which ones you buy. Some you need to track daily, others, hardly ever. Some are extremely volatile. Personally, I am wary of ETFs and do not invest in them myself for various reasons.
(See this interesting article about ETFs: http://www.springreef.com/springreef-insights/exchange-traded-funds-etfs-proceed-with-caution/)
Depending on how one looks at stocks, investing in an individual company can be the most complicated, yet the most rewarding. Buying a stock is just buying a slice, or part ownership, of a company. Sounds simple, right? Someone can even make the process extremely simple by saying, “I shop at Walmart and really like the store so I’m going to buy the stock.” This can, and does, work out for people… sometimes. But is this really a prudent way to invest? Do you really want to risk your hard-earned money taking this approach? My belief is that in order to invest prudently in a company you should know the basics of accounting, business fundamentals, and have studied the stock market well. You should also know yourself really well to be a disciplined person who does not let emotions get to them and can view the world objectively. If you do not meet that criteria, at the very minimum, I do not believe you should invest in individual companies. There are way too many pitfalls to investing in individual companies where permanent loss of capital can be the end result. Also, if you’re going to invest in individual companies, your goal is to beat out index investing at the very least, a pretty tall order (remember the S&P 500′s 9.4% annual return?). So, if you can passively invest at around a 9.4% return annually, you really need to be extremely dedicated to learning about individual companies if you’re going to go at it alone. However, for those who wish to put in the time and effort, investing in individual companies can be the most rewarding, as the greatest investor, Warren Buffett, can surely attest to. If you had invested $1,000 in 1965 in the stock of Berkshire Hathaway, Warren Buffet’s company, you would have nearly $4 million today.
The main goal of this blog is to explore the last part of the investing process presented, investing in stocks, with the ultimate goal of empowering the individual investor. Over many posts, I’ll explore the strategies and philosophies of the greatest investors, analyze individual companies, present market history and data, show tools which can be used to guide the investment process, discuss my own strategies, explore business fundamentals, psychology, and other topics related to investing.
——Written by: The Poor Investor