Fact: You don’t have to read a bunch of books to become a smart investor, BUT you do have to understand a few basic principles. Here we go, your 5 simple rules:
Rule 1: Start Early
Start investing today, better yet start right now! Even if its just $5, there will never be a better time. Here’s why: Compound Interest. There’s an urban legend that Einstein once called it the most powerful force in the universe; the eighth wonder in the world, mankind’s biggest discovery! Did he really say that? Who knows?
Let me explain why compound interest is the single most important thing you’ll ever learn. Know that compounding indicates an action building on another. Let’s consider a snowball. Now, roll it downhill. Meter by meter that small ball of snow would pick up more and more snow, growing until it becomes a huge snowball. That’s exactly how compound interest works; it builds on itself!
Or another way of saying it, is that you get interest on the interest that you get paid. Then you get some more interest on that interest. Pretty soon the interest you’ve earned is way bigger than the money you put in there in the first place.
Just like your giant snowball is way bigger than your little snowball you started out with. This is a really important concept so let’s leave the snow behind and look at it another way.
Imagine we have two brothers one’s 30 and the other’s 40 years old. They each start putting away $10,000 per year until the time they retire at 65. So, at retirement age the 30-year-old has invested $350,000 and the 40-year-old has invested $250,000. That’s a $100,000 difference, a good amount, but nothing crazy. Now how much is that $100K difference turn into over time due to compound interest at 5%? The 30-year-old brother has $958K whereas his 40-year-old brother has $511K. That’s a life changing amount of wealth to lose out on for only missing 10 years of investing.
Think about it. That’s the kind of money you leave on the table if you don’t start investing early. But if you’re like the older brother that didn’t start investing early, don’t panic, remember to just control what you can and start today.
Rule 2: Don’t Pick Stocks
Remember the story of the monkey that outperformed all those professional stock pickers? If you’re wondering if anything’s changed since 30 minutes vs 50 years ago? It hasn’t. Recently this same experiment was run only this time they swapped out the monkey for a loveable cat named Orlando. So, we had an animal not a human randomly picking stocks and over the course of a year, Orlando’s stocks had a better return than ones picked by top stock pickers at top investment firms. The moral is don’t bet your retirement on picking stocks. Don’t pay an expert to pick stocks for you. Instead invest across the stock market as a whole.
So, how do you invest in the entire stock market? Buy one of every single stock? Luckily there’s a much easier, cheaper, and more effective way. Index funds, also known as ETFs (Exchange Traded Funds) and they track the entire stock market for you at extremely low prices that brings us to your next rule!
Rule 3: Keep costs low
Usually in life the more you pay for something (your clothes, your car, your house) the better it is. The opposite is true when it comes to investing. Paying a financial advisor 2% a year in fees. This may not seem like much now but over the course of a lifetime it could add up to $100s of thousands of dollars. It's kind of like compound interest we talked about before but here it works against you. Meaning all those fees can really snowball out of control.
Let’s look at two people that invest $1,000 per month for 30 years. The first pays 2% in fees and the next pays just 1%. A 1% difference might not sound like a lot, it could cost you $100,000. Congratulations, you just bought your expensive advisor a Ferrari.
Rule 4: Diversify
Investing in stocks and bonds comes with risk that is partly why it can be very lucrative. You’ve probably heard that it's good to have a diversified portfolio, it's just another way of saying don’t put all your eggs in one basket. Imagine what would have happened if you had invested 100% of your money in Blockbuster? (R.I.P.)
Smart investors find ways to manage risk. One important tool they use is diversification, if you spread your investments or eggs across lots of companies in lots of different industries (like green energy, pharmaceuticals, tech) in lots of different countries. You can protect against the ups and downs of any one part of your portfolio. Diversification is your best friend.
Rule 5: Tune out the noise
Emotion is the enemy of the smart investor. It’s easy to get emotional; “The market’s up, I made $172!” or “The market’s down, where’s my damn $172? The world is ending! Sell everything!” But history has shown that trying to time the market usually leads to worse returns. Don’t listen to the entertainers, who yell “Buy” or “Sell”. Have the conviction to stick to your plan, in both the best and worst of times. Investors who chase performance or run away from losses are doomed.
The thing that differentiates good investors from bad investors is simply the discipline to drown out the noise and stick it out for the long run. Now you might be saying the 2008 recession was hardly noise. You’re right it had a huge impact on a lot of people’s life savings and affected the economy for years.
It doesn’t pay to panic- the people who panicked and sold everything when the market bottomed in 2008 to cut their losses missed out on the next 10 years, which has produced some of the greatest returns in the history of the stock market. Point is you can never know when a recession might hit but smart investors stick to their plans and think long term no matter what.
And after learning these 5 simple rules that’s what you are, a smart investor.