Yes, that is the most boring title ever, but please read anyway. This is important.
The Sheep and the Wolves: Smart Investing Made Simple had some great advice for all investors. There are always risks — especially in the economy we’re suffering through now where a major crash is possible — but this advice should work well regardless. The risk of completely sitting out of the market is that inflation drives stocks up for a time and you miss out on those gains.
The odds of you timing the market perfectly or even well are extremely low. Most experts can’t even do it.
Even picking individual stocks is a challenge for amateurs and pros alike. When I used to work for Compaq / HP I sometimes had access to earning per share results and projections, the holy grail of investment information (no, I never abused it — I always invested steadily and could only trade in narrow windows each quarter). But even with that knowledge I couldn’t guess where the stock would go, because we would sometimes see the stock dip even after record earnings. Why? Because of some comment about future earnings or even a misstatement by our CEO or CFO. The lesson? Don’t try and be an expert about market timing. Even with the ultimate inside information I still wouldn’t have been sure to win.
I also saw how a company could drive up a stock price by mortgaging the future. They would rush out a new product to hit quarterly earnings then suffer for years because of quality issues and customer dissatisfaction. Or if times were tough they would consume financial reserves that had been built up in conservative years. That gave the illusion that things were still going well, but eventually the reserves ran out. In theory the Big 4 auditors would have done something about that, but their value is highly overrated (I say that as a CPA who used to be in a Big 8 firm, back before they started merging).
I was glad to see that two of the Vanguard Funds I’ve used for years were listed (VGSTX and VTSMX). Vanguard is easy to use and their low cost model is crucial, especially in down years. If your broker is churning your investments and charging you upwards of 2% over the course of a year, then in a year of 5% returns he has taken 40% of your gains, leaving you with nothing after inflation. Buying a mix of mutual funds and holding them is the key.
The other key, of course, is to start early. There are lots of ways to convey the benefits of compound interest, but no matter how much you make I urge you to start young. If you save 10% per year for your career you will be fine in retirement.
Here’s a sample of the link. I encourage you to read it all.
Stock-market investors are like these sheep farmers. Collectively, they enjoy investment returns of roughly 10 percent per year. Individually, however, things are different. Most investors suffer severe losses from the wolves of Wall Street. Wolves, by the way, who don sheep’s clothing to convince investors to trust them. (These investors also have a tendency to make things worse by selling their flocks when sheep prices fall and expanding them when prices rise.) If you want to be a successful farmer, you have to understand how farming works, and how to protect yourself from the wolves. Fortunately, it’s not as tough as it seems.
The financial industry wants you to believe that investing is difficult. If you buy into their message, if you accept the premise that you need help to invest wisely, they can charge you big bucks to handle your money. The truth is somewhat different. Investing is simple. In fact, it can be one of the easiest things you do while managing your finances. How simple? Let’s boil it down to just a few sentences.
Here’s how to invest wisely:
Set aside as much as you can in investment accounts. Prefer tax-advantaged accounts (like a 401(k) or Roth IRA) before taxable accounts.
Invest all of your money in a low-cost stock index fund, such as Vanguard’s VTSMX or Fidelity’s FSTMX.P
If the stock market makes you nervous, allocate some portion of your money to a bond fund. Or invest instead in a low-cost combo fund like Vanguard’s VGSTX or Fidelity’s FFNOX.
Continue investing as much money as possible. Never touch it. (Nothing makes a bigger difference to the size of your flock investments than how much you contribute.)
Ignore the news and ignore your fund.
That’s it. Seriously. That’s all you have to do to earn returns better than 90 percent of other investors.
There are scores of books and published research papers that support this strategy. It’s also the strategy that Warren Buffett (and other top pros) recommend for 99 percent of investors. If you’d like, you can spend days or weeks or months reading about why this works. Or you can trust these folks and do it.