How to get started in the stock market
The first question I get when I tell someone I work as an investor is, “what do you think of bitcoin”? The second is, “which stocks should I buy”, or “how do I invest in the stock market”?
The answer to the first question is, I think bitcoin is a load of BS. I don’t classify it as an investment at all. It’s pure speculation. Further, the kind of people that get caught up in crypto are also the kind that fall for pyramid schemes, conspiracy theories and other belief based movements. You could also call these people idiots. And it’s better to avoid anything that they are interested in.
The second question is more interesting and it’s what I’ll be dealing with in this post.
Here is the short answer, 99.99% of people should not even consider picking single stocks. You could instead look at putting your money into an index fund.
Most people won’t be happy with that answer, so I’ll go on to explain the personal attributes required to successfully pick stocks and in doing so my aim will be to convince you to go for an index fund instead.
A brokerage account
The very first thing you need to do in order to be able to buy stocks is open a brokerage account. These days there are many phone app based brokers. I’d avoid of them. They market themselves as providing free transactions, but find other ways to sting you. I also don’t see them as stable and reliable.
Instead go for a traditional brokerage firm. Many banks have a brokerage arm that will allow you to set up an account. So you can ask your commercial bank if they provide that service.
Or you can look into international brokers such as IBKR. I don’t like their platform personally, but it does provide you access to a range of markets.
Stocks and listed index funds are identified by a ‘ticker’, for example Amazon (AMZN) and Apple (AAPL). And when you’re setup on a platform you’ll need to key that ticker in to buy or sell a stock.
Index funds
An example of an index fund is the Vangaurd S&P 500 ETF (VOO). Vanguard is the name of the company that runs the fund. What they do is buy shares in the top 500 US listed companies, according to S&P (a ratings agency). This fund is listed on the stock market, like regular shares. By buying it, you own a little piece of each of those 500 companies. Vanguard then buys and sells shares in the companies for you to re-balance the fund, so that you follow the performance of the index.
The US market has grown at a rate of about 8% over the long term. So while you’ll have years that are a lot better or worse than this, over the long run you can expect a return somewhere around this rate. And actually that is quite a nice return. $100,000 invested a rate of 8% for 20 years is $466,000. Or if you have $100,000 today and you manage to save an extra $10,000 every year and add it to your index fund you would be looking at $923,715 at the end of the 20 year mark.
Many of the top investors in the world would advise the average person who isn’t a professional investor to take this approach. In fact many professional investors themselves would be better off taking this approach, since a good number don’t actually beat the average market return over the long term.
There are different kinds of index funds. Some track European, Asian or US equities. Some track all the top companies in the world. Vanguard for me are the best, but there are other companies out there that run good index funds too. A feature of index funds, and one reason they are a compelling way to invest, is they take only minimal fees, leaving more money to compound over time.
One danger when buying an index fund is that you buy towards the top of a market cycle. Stocks could fall 20% (80% in 1929) or more from here, and you’d have to wait a long time for the market to recover. For this reason, if you have $100,000 of capital as described above, you may want to buy into the fund over time. For example you could purchase $10,000 worth of the fund every 3 months. The main thing to remember with this approach is to keep buying no matter what. Don’t stop because the market starts going down. Actually that is the best time to buy because stocks are on ‘sale’.
The best part of a trustworthy index fund like Vanguard is that you can buy and forget. It requires no thought whatsoever on your part.
But but.. I want to pick stocks
Years ago my friend bought the legendary investment book, The Intelligent Investor. It sat gathering dust on his shelf until one day I borrowed it. It wasn’t easy reading, and actually I don’t recommend it as an introductory read. But what it did do is a pretty good job of convincing me that I didn’t have what it takes to pick individual stocks.
It came down to this point: unless you’re going to make it your full time job, you really have no business trying to pick individual stocks. At least not with any substantial part of your net worth on the line.
Why is it so hard though? It’s hard because there’s a lot of money to be made, and lost. And all that money attracts some of the smartest people on the planet to the profession. Each time you buy or sell a stock, there’s someone else on the other end. When you make that move, you are essentially saying, “I know more than the person on the other side of this”. That may well be true, but for you to have a chance of knowing more than the other party, on a consistent basis, you would need to answer yes to all or most of the following.
Financial acumen
Do you have a decent understanding of accounting principles? Can you read a balance sheet, cash-flow statement and income statement? Do you have the patience to go through each line and look for anomalies? Will you take the time to read the notes to the financial statements of the companies you are interested in? Can you identify healthy debt levels, profit margins and return on equity?
And those are just some of the basics. I have to admit this isn’t my strong suit as an investor, and I’ve had to work hard to catch up. Fortunately there are many good resources out there to improve your accounting skills.
Business knowledge
Do you understand what makes one company more competitive than the other? How does the performance of management influence companies? Are you able to gauge how open and honest management is with their shareholders? Is management running the business for the benefit of shareholders or to line their own pockets? How well does the company treat it’s employees, suppliers and customers? How likely is it that this company will be able to maintain or grow its business into the future?
General knowledge
Are you constantly consuming new information? Do you enjoy reading for 5-6 hours a day about everything from the F-16 viper that is being delivered to Taiwan by the US, to the growing instability in the Sahel, and the development of solid-state battery tech? And how well do you know your history, since many things tend to repeat themselves. Were you surprised by the pandemic? Do you know about the previous major economic disasters throughout history, and the speculative manias that have come and gone? Do you know how Rockefeller built his great business empire, or how Solon reformed ancient Athens and laid the foundation for democracy?
General knowledge like this helps you to identify trends and make good investments. Unless you naturally love learning, accumulating this kind of knowledge can be next to impossible. The greatest investors, like Buffet and Munger, spend most of their days reading.
Psychology
Are you able to stay calm and logical when your portfolio is taking a dive? Do you have enough conviction to buy more of a company you like when the price is going down? Are you a contrarian by nature? Do you see opportunities when others are scarred? Do you want to get rich quickly or are you prepared to win the race slow and steady? Do you get swept up in mania, or can you make your own decisions? Do you feel like you’re missing out when others are making money, or can you stick to what you know?
The right psychology may be the rarest trait of all. And it’s debatable about whether it can be learnt.
If you go to the end of all of those questions and answered yes to most of them, please get in touch with me. We need to talk.
If the answer to many of the questions was no, index funds are a great option. If you really had the burning desire, you could learn what you need to. For example I’ve learnt how to read financial statements. I had to drag myself through it, but because it was a priority and my motivation was strong enough, I did it.
While accounting can be tricky, it is definitely learnable. The other things, especially the psychological aspect, not so much.
I was fortunate in that I had two of the most important elements that make a good investor come naturally.
The first is a natural curiosity about the world and a love of learning. Here is just one little anecdote, as a kid I used to pick out a letter from the old encyclopedias on my parents bookshelf and start reading at random. That was my bedtime reading. Learning is not a chore for me, it’s a hobby that I’ve enjoyed from a very young age.
The second, equally as important is the psychological aspect. My home group teacher at school used to call me “the non-conformist”. I never really liked following what others were doing just for the sake of it. If I found a class boring or pointless, I just wouldn’t go. In grade 5 a teacher set us a colouring-in exercise for homework. When on the next day she asked why I hadn’t done it I said, “I had better things to do”. She sent me to the principles office for my attitude. The principle (a nice man) smiled and said that I was right.
It was these anecdotes from my past that eventually made me realise that perhaps I do have what it takes to pick stocks, if I put the time in. I’ve had to work on my weak spots though. And it’s still too early to tell whether I can beat the average market return of 8% over the long term.
So there it is. I hope that gives you a good idea about which camp you fall in to. There is absolutely no shame in going down the index route. It’s the smart choice. And at some point in the future, if I want to spend more time on writing or something else, I’ll probably go down that route too.
With the stock market, time and consistency are your friends. Never underestimate how powerful regular contributions can be into an index fund strategy. Even if you start with $100 as opposed to $100,000, if you keep adding to it and leave it in there, you will do very well over time.