When I was a sophomore in college, I had a terrible internship. No, I wasn’t asked to work crazy hours or work with terrible people. I actually wasn’t asked to do much of anything. I would sit at my desk, obsessively checking my email to see if anyone needed anything from me and every few days go to my boss to see if there was anything I could do.
Eventually, I started spending my time at work reading more on how to invest (really I was trading but we’ll get to that). I read article after article about the stock market and learned everything I could. I eventually started buying and selling shares and nearly doubled my investments. I had dreams of quitting college and being a nomad living off my computer and the markets.
Then I lost nearly all my profits just as quickly and was brought back to reality.
That was seven years ago and since then I’ve continued to learn about investing. In the beginning, I lost some money but I’m solidly in the positive now. Here are the things I wish I had known when I first started investing.
1. Investing is not trading
Near the beginning of my investing career, I bought and sold shares the same day. I was focused on what are known as “penny stocks” that can rise and fall 100% within a single day. I thought to myself “if I can make just 10% on each trade, I’ll be rich in no time!” Oh, how naive I was. 10% is what most professional traders strive for in a year! And here I was, some punk still in college, thinking he could make a quick buck. I was essentially gambling with my money.
Then I read Benjamin Graham’s Intelligent Investor.
The book touches on a lot of investing principles. But one of the first things the book talks about is investing versus speculating (or trading). Graham defines investing as a process that “upon thorough analysis promises safety of principle and an adequate return.” This is in contrast to a trader who “gambles that a stock will go up in price because someone else is willing to pay more for it.” I really had no credible basis for the stocks I was purchasing and consequently lost money. After reading the book, I went back to the basics of investing, reset my expectations for future returns based on past performance, and decided to implement an investment plan instead of trading.
When you start investing, be realistic with your goals and don’t gamble with your money by trading. If you’re interested in becoming more knowledgeable on the markets and investing, I highly recommend The Intelligent Investor by Benjamin Graham.
2. Taxes matter… A lot
Though I started day trading during my sophomore year in college, I purchased my first stock back in high school. Since that time, I’ve realized how much taxes have an effect on my take home pay. Paying taxes is a double edged sword since it not only eats directly into your immediate cash, it also takes away money that could be reinvested. Efficiently managing your taxes can mean having nearly twice as much money in retirement!
In 2018, a single individual making $60,000 was in the 22% tax bracket. On top of paying 22% of your income from your job, you also have to pay taxes on any gains from your investments as well. If you’re buying and selling shares regularly, like I was back in college, your gains are essentially taxed like income. So if you make a profit of $100, you actually have to pay $22 in taxes making your profit only $78.
But profits from investments fall into one of two categories: short term or long term. In the case above, the profits are considered short term since the investments were held for less than a year. If you instead held your shares for a year or longer, any gains from the sale of those shares would be considered long term gains and taxed at a lower rate. For a $60,000 earner, long-term gains are taxed at 15% instead of 22%.
But you can do even better. By using tax advantaged accounts like IRAs and 401(k)s, you can avoid paying taxes on your earnings altogether. That’s right, if you gain $100 from the sale of a stock, you get to keep all $100. If you have $10,000 that grows at 8% annually, whether or not you pay taxes is the difference between $58,000 and $100,000 after 30 years. If you’re investing for the long term, make sure your investments are in tax advantaged accounts before beginning to put investments elsewhere.
A lot of people think of the glamour of picking the next hot stock when first starting to invest (at least I hope it wasn’t just me). One of my first stock picks was EA Games. I purchased it because I loved video games at the time and I knew they had one of the best lineups in the business. I bought their stock and a few weeks later, it shot up 20%! I sold it and made a nice little profit as a high school student.
Looking back on that move, it was sheer dumb luck. Since then I’ve had plenty of other stock picks that weren’t so hot. One of my picks ended up being an 80% loss!
I now know I’m no wolf of wall street. Putting your hard earned money into a single stock can be a costly mistake if that stock performs poorly. Instead of choosing individual stocks, I now diversify using ETFs that follow the broad market indexes. Doing this essentially allows me to own a little bit of thousands of companies. If one company in the index does poorly, there are two or three others that are doing well. This allows me to avoid the pitfall of having my portfolio depend on a single stock.
In addition to diversifying across different stocks, my portfolio now includes a small portion for bonds as well. When stocks perform poorly, bonds usually hold up well, so that provides my portfolio with some stability in different market conditions.
I specifically like VTI and BND. VTI is Vanguard’s ETF encompassing nearly the entire US stock market. BND is the bond equivalent of VTI. Today, I’m nearly 90% in stocks but as I get older, I’ll likely move more of my assets into BND since it’s more stable and less volatile. I’ll always keep at least 50% in stocks though.
Either way, I’m wise enough now to know that I can’t identify winning stocks. Instead, I’ll just invest in the entire market. After all, it’s done pretty well in the past.
4. Time in the market, not timing the market
When I was trading, I was focused on buying and selling shares at the right prices. Today, my overall investment strategy involves investing in the market as a whole.
The general market doesn’t have smooth returns. It goes up and down on a daily basis. Trying to time that is a fool’s errand and akin to gambling (see point 1 above). Even mutual funds managers, who are supposed to make a living by timing their investments, fail to beat their market indexes almost 85% of the time.
The S&P 500 has an average annualized return of 9% over the last 90 years. At that rate, your investment more than doubles every 10 years. In fact, if you take the 30 year period starting from January 1987 to January 2017 your original investments would be worth over 9 times as much.
As I mentioned though, that kind of return doesn’t come smoothly. That period includes Black Monday (the worst day in stock market history), the dot-com bust, and the Great Recession. Looking back, it’s easy to think that you could make more by selling at the top and buying at the bottom. But that’s nearly impossible to do in real time. Instead of figuring out the best time to get in and out, use the market averages to your advantage and invest on regular intervals regardless of what the market is doing.
If you invested $500 a month into the S&P 500 for the 30 year period from 1987 to 2017, you would have invested a total of $180,000 which would have been worth over $570,000 by the end. Staying in the market for the long haul helps you realize larger gains. But if we take a look at the graph below, you’ll see 2 areas marked as high growth.
Those 2 time periods alone, just 6 years, account for almost 80% of the portfolio gains. Unless you’re a fortune teller, you’ll never know when those high growth periods are coming. That’s why it’s important to stay in the market for a long period so you can benefit from the market increases when they happen. When the markets go down, weather through the storm until it’s over. Eventually, the market will enter into another period of high growth where you get to watch your portfolio grow.
Investing is difficult and plenty of people lose money in the markets. But it’s impossible to build wealth without investing. Use these tips to avoid the pitfalls I experienced and start your investing off right.