Buying Stocks in 2020 - Part 2: Buying your first stocks and how much to invest
In Part 2 of this series, we’re going to go through:
Setting a regular investment amount to achieve your goals
How to choose a trading platform
Different investment strategies
Buying your first stocks
In Part 1 we covered common misconceptions about stocks, how the stock market works, and compound interest. If you missed it check that out first.
This isn’t a get rich quick scheme, it is a get rich slow plan.
Of the top 5 richest people in the world, 4 made their fortunes as CEOs of successful companies. The one investor on the list, who also happens to be the eldest, is Warren Buffet.
Warren Buffett built his fortune by consistently investing in stable and well-managed companies over a long period of time.
He recommends consistently investing on a regular basis, called dollar-cost averaging, and then reinvesting the profits to create compound interest which we’ve talked about in Part 1.
Investing consistently (dollar-cost averaging)
Timing the market is really hard, you might get a low price but you might also buy at a peak. No one can accurately predict market movements - especially in short time windows. Instead, you should figure out how much you can afford to invest each month and buy consistently which will ensure you get a good average price.
Below is a dollar-cost averaging example where you buy 1 stock every month rather than trying to time the right moment.
The next part is all about letting the compound interest do the work - if you're hitting 10% returns or more each year your money will at least double every 7 years. All you have to do is not take out money, we covered it in more detail in Part 1. This means you should only invest as much as you’re not going to need access to and any fees you pay for money management, tools, and transactions etc. subtract from your compounding. It might seem like a small amount in the short term but can become a large sum over time.
One thing to note about Warren Buffett's higher than average returns is he's been able to invest with leverage (I talk about that more here) and investor money which I talk about below - the effects of patience, consistency, and compounding are still very impressive.
Using a financial goal to understand how much to invest -
I have found it helps to set a financial goal you want to achieve and estimate the time you have to do it. In the below example it will take me 30 years to get to $1MM saving $500 a month.
How much can you afford to invest on a monthly basis at the moment?
How long do you have until you want to retire?
Fill in the Compound Interest Calculator along with 10% interest rate and a yearly compound interval (example for $500 a month below)
Adjust your monthly saving and see how it impacts your final amount. Could you reduce your expenses a little so you could save some more?
Complete the following sentence for yourself:
“I need to save __ for __ years in order to retire with __”
Choosing a trading platform -
There are a ton of different trading platforms available to you, particularly if you live in the US. All you need is a computer or mobile phone and a bank account - no other equipment necessary.
The main criteria to check are:
They don’t charge transaction commissions since this will eat into your returns (most don’t anymore).
It’s easy to use. When you download the app or sign up, if you don't find yourself able to use it after 10-20 minutes of looking around you might be using the wrong product.
Provides the features you need - mobile app if you want to be able to manage everything on your phone, auto-invest if you want to not have to think about it etc.
Here are three to take a look at:
Best for - Beginner and Passive investors
If you don’t want to spend 5+ hours a week researching stocks then M1 Finance is perfect for you. It provides auto-investing functionality so you can set a monthly deposit amount which it will invest in your selection of stocks. You can set it and forget it once you’ve selected some stable stocks, which is ideal for dollar cost averaging and allowing interest to compound.
Best for - Beginner/Intermediate Active investing
(US only, launching in the UK in April) -
Robinhood is also commission-free but is geared towards active investing and so the news, stock info, and alerts are fantastic. If you are planning to spend a lot of time researching stocks and want to try to beat the market Robinhood will be best for you. It doesn’t have the auto-invest features of M1 finance.
Best for - UK and EU investors
Being in the US, I haven’t used Freetade, however, the European investor community rates them well. They don’t charge commissions but do have a membership fee which you should factor in. Wealthfront and Betterment etc. are not good choices for your money in my opinion. The scheduled deposit and auto-investment follows the same principles as above which are great, however, they distribute your investments suboptimally and charge a fee to do it which eats into your returns significantly over time.
There are three broad styles of stock investment strategy:
Active investing - The goal for an active investor is to ‘beat the market’, which in the US means outperforming the S&P 500 since that’s an average of the top US companies. Almost no one does this successfully over time. This requires significant domain expertise, resources, experience, and time spent researching companies and markets - it also requires borrowed money since all of the things I just mentioned are expensive and would hugely into a return. That’s why the majority of active investors are what are called Mutual Funds and Institutional Investors.
Managed Funds - Companies which pool money from investors and invest it on their behalf into stocks and other investment vehicles. They will charge around ~1% of to do this, which will pay for their large staff. As mentioned in the compound interest section - you don’t want people eating into your returns, especially when you don’t need them.
The image you have of investing, although hopefully it is changing, is either an active investor or stockbroker. Someone making huge amounts of money making quick trades and outsmarting the average investor with sophisticated tools, analysis and genius instincts. The reality is the people making huge amounts of money are salespeople making it from fees, not the analysts picking investments.
Passive Investing - You invest for the long haul and limit the amount of buying and selling within your portfolios, that means resisting the temptation to react or anticipate the stock market’s every move. It is a very cost-effective and low effort way to invest.
We’re in this for the long term like Warren Buffett so I’m going to focus on the Passive ‘buy and hold’ strategy, which means we’re going to buy stocks with the plan to hold them for several years.
For a beginner or intermediate investor willing to spend a few hours a month checking on their portfolio, Passive is likely to net you as high or higher returns than both Mutual Funds and Active investing and will reduce the amount of risk you open yourself up to. As you become more experienced with investing you may want to become more active.
Even when Active investing avoid trying to make quick money by buying stocks on recent fads. Fads often lead to high volatility and are equivalent to gambling with your money. We'll talk more about that in Part 3.
Your stock portfolio
You might have heard people refer to their stocks as a portfolio. That’s because at one point stocks were pieces of paper held in a portfolio folder.
Many experts recommend owning a diversified portfolio of stocks, which means you invest in different companies, industries, and geographies to protect yourself from an economic downturn if you’re concentrated in one area.
The trouble with diversification is it quickly becomes difficult to keep up to date with your investments. You will miss things you would have noticed with a more focussed stock portfolio and your underperforming investments will bring down the returns on your better ones averaging out or worse. This is why people pay for advisors or fund managers to stay up to date for them, but their costs massively eat into your returns over time and history shows they don’t do much of a better job.
So how do you diversify your portfolio and at the same time limit your investments to a manageable amount which you can remain up to date on yourself? Enter the ETF!
Exchange-Traded Funds (ETFs) -
One of the best ways to invest passively while diversifying is to buy stock in an Exchange Traded Fund (ETF). An ETF is a collection of stocks which you can trade like a single stock, the most popular and highest performing being the Standard and Poors 500 (S&P 500). When you buy 1 S&P 500 stock you’re buying a % of the top 500 stocks on the US stock market. Other countries have their equivalent, in the UK there is the FTSE 100 and in Hong Kong the Hang Seng Index.
The S&P 500 is great for investors looking for portfolio diversity with less time on their hands since it is self-managing. If a company over or underperforms the fund will increase the %, weight, that the company makes up of the 500. It has returned an average of ~10% annually and returned 30% in the last 12 months. You win when the US economy wins, if you lose money pretty much everyone does.
Benefits of the S&P 500:
Diversified across industries
Automatically tracks to performance of companies
Very low management fees- 0.04%
Only covers the US market.
Here is a full list of companies in the S&P 500: https://www.slickcharts.com/sp500
Selecting the right ETF for you -
You can find ETFs for pretty much any industry you are interested in. You’re investing in the average performance of what the ETF is focussed on, some examples:
Top 500 US companies: S&P 500 (VOO)
Gold: SPDR Gold Shares (GLD)
Tech: Technology Select Sector SPDR Fund (XLK)
Retail: Amplify Online Retail ETF (IBUY)
Coffee: iPath Dow Jones-UBS Coffee (JO)
Most people would be best buying the S&P 500, a point that I might have laboured to death but can't stress enough, as Warren Buffett says ‘never bet against America’. However, if you have a strong belief in another market or industry long term this is a great way to invest.
My recommendation is to use at least 50% of your regular investment to passively purchase an ETF like the S&P 500 and let that money compound.
In the next instalment, I’ll talk about choosing individual stocks and how to compare them to understand if your paying the rich price. In the meantime, you can happily invest 100% of your monthly stock investment money in the S&P 500 or the passive ETFs you chose and will probably make more returns than if you try to pick individual stocks.
To summarise you should now be able to:
Decide your regular deposit amount
Know how much that will earn you over time if you hit 10% returns
Choose and download a trading platform
Select ETF/s for more than 50% of your investment amount
Buy your first ETF stock/s
In Part 3 we will dig into:
A framework for choosing the best companies for you to invest in
How to know if you're paying a fair price
Analyzing a company's competition
As always, I know there is a lot of content here so if there is anything you would like to ask questions about please reach out - I’m happy to chat about it!