Three Simple Stock Market Rules For Me And You
If you want to understand the stock market and how to personally benefit from it, I have three simple rules for you:
- Start now — it is easier than you think!
- Do not try to beat the market.
- Buy low, sell high.
My advice rests on a few basic assumptions. If you are completely broke, I doubt I can help you. This is for people who feel comfortable setting aside money to invest, maybe on top of a 401(k) or pension. With that said, you should always be asking yourself, “Can I save more? Can I spend meaningfully less?” The answer is almost always yes, for all of us. Managing your finances requires discipline but also rewards creativity and harshly punishes ignorance. I hope to dispel some of that ignorance for reasonably intelligent folks who are not living hand to mouth but are unsure of where to start.
Rule 1: Start Now — It Is Easier Than You Think!
Also known as the power of compound interest. Essentially, the longer you invest in an asset whose value grows, the more times you will earn interest on your interest. It is the mathematical equivalent of a snowball effect, producing exponential growth from a steady return. If you invest $100 for 20 years assuming a 10% annual return, you end up with $672.75 (rounded up). Forty years? Glad you asked: $4,525.93! From a hundred bucks! Save and invest as much money as you can as soon as you can, which given humanity’s relationship with space and time is right now.
If you have not started, today is the day. Speaking from painful personal experience, it is easier than you think. I misspent about nine months procrastinating on setting up a Charles Schwab account and when I finally sat down and did it, I was surprised by how simple it was. No more complicated than signing up for an email or social media account, really.
I could try to walk you through it but honestly, just do a little research to pick a brokerage and go for it. I feel comfortable saying the process is almost idiot-proof, just take it slow and do not accidentally email anyone your bank information. The brokerage industry recently finished a long price war, resulting in wide availability of commission-free trades. So you buy and sell stock without paying any fees. (I had a spreadsheet for calculating how often to buy stock given various assumptions, but no longer need it.)
Shortly after creating my brokerage account, I also realized I had lost out on a solid run of the S&P 500. Compound interest is all about opportunity cost, but what is past is past, so minimize your regret by acting now.
Rule 2: Do Not Try To Beat The Market
Beating the return of a major stock index, never mind consistently, is almost impossible, which is almost an understatement. Sure, it does happen, but there is plenty of evidence to suggest that even most of the pros’ pros who beat the market year after year are, statistically, more lucky than smart. In crude terms, a few people win the lottery. That means their performance is not reproducible. And all of this risks underemphasizing how incredibly rare it is to beat the market. The people who do based on skill are some combination of well-capitalized (lots of money to spend on their strategy, lots of money to invest, likely belonging to wealthy individuals) and extraordinarily intelligent (use your imagination here). No offense but you, person reading this, should just quit while you are ahead. Comparisons of the stock market to a casino are popular and more than a little accurate, given the amount of greed and unethical behavior permeating both. But arguably the most valid part of the analogy is that the house always wins. That is, the players almost always lose.
As the saying goes, if you can’t beat ’em, join ’em. The best bet in the stock market is betting on the whole thing, or more precisely on a stock index, like the S&P 500, which was my choice by default. Putting money in so-called index funds, also known as passive investing, is a now widely practiced strategy popularized by Princeton economist Burton Malkiel’s 1973 book, “A Random Walk Down Wall Street.” It used extensive evidence to argue that people who pick individual stocks might as well be tossing darts at a board. Malkiel is a prominent proponent of the efficient market hypothesis, which for our purposes boils down to the proposition that market prices reflect the knowledge of a huge number of people, and no one individual is likely to consistently outsmart the rest. Speaking for myself, I certainly have no delusions that I would be able to. Nor would it be worth my time to try. If either of us had a shot at this, my friend, you would not be reading my post and I certainly would not be writing it.
My portfolio is dead-simple: VOO, Vanguard’s S&P 500 Index Fund ETF; and for basic diversification, VT, Vanguard’s Total World Stock Index Fund ETF. Vanguard is an investment company founded by the late Jack Bogle to offer low-fee index funds to regular people. Passive investing has become so popular that passive investors own huge swaths of the stock market. But you do not need to worry about all of that. Just do not try to beat the market.
Rule 3: Buy Low, Sell High
At the height of the #GameStonk mania I wrote out a little parable for my Facebook friends which somewhat undermines my admonition not to try to beat the market. A related rule is not trying to time the market, which would be putting money in right before a bull run or pulling it out right before a crash. I would never advise attempting this … but basically pulled it off after the market crashed early in the COVID-19 pandemic. This was not the product of my intellect, just the application of a third simple rule, championed by investing icon Warren Buffett: Buy low, sell high.
Take yourself back to the coronavirus crash. Having invested for years in index funds, my wife and I were actually in the red — we had lost money. She was understandably questioning if we should cash out to avoid losing more. I persuaded her we should not since we were planning to hold for many years and the market would eventually go back up unless civilization collapsed, which because the virus was milder than bubonic plague I felt confident of. For the same reasons, I actually convinced her we should put some money in, not a huge amount but about as much as we usually would in one shot. You can probably guess the rest. The market was back up to a record in 2020 and our lifetime return now sits around 45%. Our year-over-year return was something like 160%. Just the market doing market things, whatever that means. Price-to-earning ratios are as grotesquely high as they were for two previous bubbles — dot com and housing — but…. we still plan to hold for decades.
Buy low, sell high can be tough to stomach. But you only lose cash when you sell low, which Warren Buffett would mercilessly scold you for. To be perfectly honest I leaned really heavily on my exposure to basic finance through a bachelor’s degree in economics. My reptile brain was freaking out like anyone else’s. I had to really stop and think. But I just followed these simple rules.
Now that you have digested all three rules, I want to close by pointing out something you are likely wondering yourself: Why do financial advisors exist, particularly the archetype of the man in a suit selling you high-fee mutual funds that do not beat the market? The best explanation I have is ignorance. People have never heard of a random walk or Burton Malkiel or Jack Bogle. Maybe they have heard of Vanguard, but the name runs together with other financial behemoths. Most Americans have heard of Warren Buffett, but think of him as the guy who beats the market by picking value stocks based on rock solid fundamentals. But we cannot all be Warren Buffett. The best nearly all of us can do is going long on the whole market, buying low then selling high.
