Picture by Sharon McCutcheon.
Note: I’m by no means an expert on this topic, everything described here is simply what seems reasonable to me. Also, the strategy I present here will only work when used over the long run, it’s not a recipe to make money quickly by gambling. If you’re looking for a slightly more complex and even better approach, I’ve written some more here
Investing is probably one of the most complex (mundane) activities there are nowadays. However, I’ve noticed that many people think they can outsmart the markets, which is just not true in general. Other people in turn think they need to be able to do so in order to invest successfully, which is just as far from the truth.
Well, while you might have the Midas touch for picking stocks for some time, this approach will inevitably fail you someday, namely when Fortuna¹ leaves you. Also note that for pulling this off you’d not only need a big chunk of luck, but you’d also have to spend a big chunk of your time picking your stocks. And time is money, right?
But not everything is lost!
I’ll present a simple and minimalist (in terms of effort, risk and worry, not in terms of returns) approach to investing in the following paragraphs.
A share is a slice of a company that you can buy.
Depending on the amount of shares available, you buy yourself x% of the company, which gives you the right to attend the shareholder’s meeting, where you can then vote on crucial company decisions. As a part owner, you of course also participate in profits, which is called receiving dividends. This will probably be your main focus, as I assume you don’t own a big proportion of a company, which would make your votes in the shareholder’s meeting more influential.
The value of a share is the value of the dividends it will yield over time, which depends on the amount of money the company will make over time, which in turn depends on a whole lot of other things.
These other things can for example be outside influences like new policy regulations, international affairs, events like natural disasters, new trends in the economy, politics or society as a whole.
And it doesn’t even stop there: All these already uncontrollable (and unpredictable!) things are then run through peoples minds and their estimates of those things and their future development determines the price of a share, making it even more absurdly unpredictable. Because just as the assumptions of all the people buying and selling shares of a company change every day, so does their price. We’re not just talking about the future value. We’re talking about perceived future value.
So not only can you not control a single of those (numerous) influences or the minds of other people, you also can’t grasp them all at once and definitely not foresee them!
I think when presented so clearly with the facts, nobody can maintain the utterly unrealistic belief of being able to predict a single stocks price reliably and to a relevant degree.
So stock prices change everyday in a way that’s really impossible to foresee.
However, if you look at the general development in the past, you’ll quickly notice that in the long run (> 5 years), markets rise.
We’ll take this as an axiom.
If this is true – and it currently seems to be –, every fluctuation is just noise and you can confidently ignore all the occasional crashes as well, because you don’t depend on the money being paid out exactly then, as you’re in it for the long run anyway. So this is what we’re building on.²
What stocks should you buy?
All of them!
As we’ve seen above, the only thing we can rely on is statistics and the general rise of the economy. So the trick is to just buy the market average, while avoiding costs. There’s actually a term for this and it’s index fund.
An index fund or ETF (exchange traded fund)³ is a portfolio of stocks, which mimics the composition and performance of a whole index. As we’ve also seen, it’s the best to just mimic an index completely, so you want to go for passively managed funds instead of actively managed ones. They also have lower costs, as there’s almost nothing to do and no expensive manager to pay.
This approach will not only give you more safety (in form of diversification) than investing in single stocks, it will also outperform any single investment in the long run.
There are ETFs that mimic an index or the economy of a whole country or even ones that mimic the whole world or a part of it. For example you could go with the MSCI World, which covers the biggest companies of the industrial countries. It mimics the performance of more than 1.600 companies out of 23 countries and since 1975 had an average yearly return of 9%.
There are websites to compare different funds, so go ahead and choose one (or multiple ones). The things you should look for are:
When should you invest?
All the time!
Use a savings plan. This basically means you set aside some money every month to continually invest smaller sums instead of doing one large investment.
This way you’ll be able to invest early, as you won’t wait for a good time to start (low prices), which means you’ll have more time and thus growth to profit from⁴. You also won’t suffer from a bad time (high prices), as you’ll spread your investment over time.
It’s useful to take a quick look at the compound effect:
Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest.
This effect is the secret weapon of investing, as it’s basically saying the more you make, the more you make.
With this secret weapon, you’ll be able to increase your profits without even having to put in more of your own money. You have to reinvest your money. Some funds do this automatically, but you should definitely reinvest all the money you make from investing (at least in the beginning) to increase your future profits and make use of the compound effect.
This article is probably best summarized by this sentence:
Use a reinvesting index fund/ETF together with a savings plan.
Using our axiom that the economy in general is constantly rising over longer periods of time, we can conclude that it’s best to profit from that general rise by using an index fund/ETF. It’s also smart to spread the investment over time by using a savings plan. By reinvesting the profits we can leverage the compound effect.
This way, we’ll be safe from crashes and fluctuation. We also won’t have to think about fancy investment strategies or worry about risky investments.
It really seems to be as simple as that.
¹: I know that I just mixed up roman and greek mythology, but have you ever heard of Tyche?
²: Note that this axiom might not be true forever, but I think at least for the next lifetime we should be good with our assumption. So until then, you can profit from the rise of the economy in general and roughly ignore all the fluctuations.
³: There is a difference between index funds and ETFs but for our purpose here I believe this difference is insignificant.
⁴: Of course it would be optimal to wait for low prices, but as noone knows how prices develop that time may never come. We’re not gambling here, we’re looking for a simple way to invest.
If you want to give me some feedback or share your opinion, please contact me via email.
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