Investing is simple… depending on your strategy. My belief is that indexing (also called passive investing) is the best way to invest. There is data that shows passive investing outperforms the majority of the time and is less expensive (in both manager fees and taxes). I can also say from experience that passive investing requires less work for the investor. A better likelihood of investment success and less work for the investor is a win-win.
It can be slow and boring at the start, but those that keep with the strategy will be happy when their investment accounts start snowballing from compounding returns.
Generally, the premise is to invest in low cost passive ETFs or mutual funds - Vanguard is a great place to start to get an idea of what is out there. Many of the large custodians like Schwab and Fidelity have their own index funds as well.
In no particular order, here are five points to keep in mind when deploying this type of strategy:
One bad decision can undo many good decisions
We live in a crazy world today. My dad was just telling me about getting his bank statements each month or quarter in the mail! No wonder there are some wealthy boomers out there - even if they wanted to actively trade their accounts, there were much bigger barriers to so.
Now, some of us check our bank balances out of boredom or when we just need something to do with our hands - and even some banks (you’ll never guess who) created their app interface to be like a game when it comes to investing.
Investing isn’t gambling - its slow and boring. Investing isn’t to create wealth, but to grow your wealth.
Unfortunately with meme stocks, crypto shenanigans, etc. a whole new breed of investors is growing up in this time. I fear for their wake up call due to the behaviors they have formed that they will have to overcome when this craziness levels out.
Anyways, with that said it leads to my point - I think there will be a lot of wake up calls for investors that have started in the past 10 years. All they have seen is investment growth in their portfolio and any down turns in the market quickly recovered. Don’t let this fool you - being reckless can create huge issues and everything doesn’t go up all the time.
Stay with the tried and true strategy of investing in ‘boring’ businesses, and don’t let the allure of a quick dopamine rush ruin all your hard work of saving and growing over time.
Unrealized gains / losses are different than realized gains / losses
“Unrealized” just means you haven’t sold your investment yet. “Realized” means you have sold your investment.
I point this one out for two reasons:
Unrealized gains are not the same as realized gains. Compounding returns are when your unrealized gains continue to grow on themselves. If you decide to sell your investment, you both pay taxes for the sale and lose the ability to let the investment compound. This is why it is so important to have a buy and hold strategy to let those things grow over time.
Unrealized losses are not the same as realized losses. If your portfolio takes a dive, this only impacts you if you sell it at a loss and miss the recovery. These are just paper losses if they remain unrealized, and as long as you believe in the recovery of the investment you hold, there is no need to sell and realize that loss.
Sometimes, the best thing to do is nothing. But what if you need that money in the middle of a portfolio dive?? I’m glad you asked...
Determine your time horizon
There are many ways to think through this, but the easy question should be “what is the chance that I am going to need money from my portfolio within five years?” This is being proactive and thinking about your cash needs BEFORE making that investment.
Five years is a baseline - the 2008 great recession took about 4.5 years for equities to fully recover. The COVID pandemic took about 6 months. This is highlighting how unknown recovery times are, as well as unpredictability with when downturns occur.
I chose five years because you would think if something called the great recession can recover in that time, then most other events can too. But we all know the famous “past performance is not a guarantee of future results” and anything can happen going forward that we’ve never seen before. Keep that in mind. The longer time horizon you have, the more confident you can feel in the strategy.
So, if you don’t need the money in five years and it takes a dive, this is no harm no foul and you can do nothing; it is just a paper loss, and you can wait for it to recover.
You get yourself in trouble when you need that money during a dive. Now, you have to sell at a loss and don’t have the money invested for the recovery. This is a big mistake and gets A LOT of people in trouble. So two takeaways:
Have a buffer available for this instance, whether that be your job income, ability to pull debt from somewhere, emergency fund, safer investments to buy time, etc. You shouldn't be investing if you don't have this buffer and may need the money in the short term.
Don’t panic sell - if you don’t need the money, just keep it there and let it recover over time.
Consistent investment is more important than investment timing
Historically, investments have always gone up. That is why we are still hitting all time highs in the stock market.
Typically, the earlier you are invested, the more upside you receive. This shows that putting money into the market as you receive that money is more conducive to investment gains than building a savings account and trying to enter into the market at the “perfect” time.
Time in the market > timing the market
Additionally, when trying to time the market, what determines that perfect time? You’ll always be waiting or second guessing your investment which may lead you to sit on the sidelines, missing out on valuable investment gains.
Coming up with a strategy that takes emotions out of the decisions is huge with investing. It allows you to continually add money into your portfolio and let the markets do the work.
Employer retirement accounts have done wonders for people, because it contributes to investments every paycheck without the employee making the decision, submitting a transfer, choosing investments, etc. It is all automated and done without the individual's intervention.
Taking the emotions out of the decisions in this way has helped many to save consistently, and can be implemented beyond saving in a 401(k).
Let the markets do the work
Finally, this leads to my earlier point of putting minimal effort into your investment strategy.
Investing is a tool to grow your wealth, not create it. You will be wealthier if you focus on your saving and spending behaviors than if you put all your focus into your investing.
It takes a lot of work to find the next stock that will outperform the market - and by the time you find it you’ve probably chosen five others that underperformed the market.
Diversifying your investments is what I am suggesting here. Stick with the tried and true method of owning a piece of all stocks instead of just one or a few names.
In other words, being an equity owner is taking the stance that businesses will continue to grow. I’m a firm believer that this is true. So, owning a lot of the market is investing in the success of businesses, not just one business.
There is a lot of oversight with businesses among environment factors, corporate governance, DEI initiatives, etc. There are a lot of factors that can put a business in a bad light that will do negative things to its stock price.
So, I feel much more comfortable being invested in all businesses and not taking a risk that the one business I invest in has an issue with its leadership, which we’ve seen is all too common.
Understanding how markets work and what the true risk of being invested is really important to the behavior of an investor - and will ultimately be one of the most important factors in determining an investor’s success.
Discipline, consistency and patience are the core tenants when it comes to implementing a successful investment strategy.
In my role as a financial planner, I find a lot more value in the planning around savings, tax planning and reviewing the whole balance sheet as opposed to just the investment accounts. An investment strategy is very important and I do not want to downplay that, but can be a simple approach and still achieve positive results.
My suggestion is to focus on the things that will move the needle, like your behavior and habits - and let the market do what it is there to do.