Happy Financial Literacy Month!
Welcome back to the three-part series on how to be a great investor.
Week 1: Before you invest
Week 2: The secret of great investing
Week 3: Staying in the game
This is it, folks. I’m going to reveal the secret of being a great investor. But I bet you’re not going to like it (originally published by Matthew Amster-Burton).
Before we get to the reveal, a quick recap of last week: before you invest, get out of debt. Investing and paying off debt are two sides of the same coin. I
f you haven’t paid off your credit cards, student loans, car loans, and other high-interest debt, make those a priority before you think about investing in anything other than your 401(k) match.
The secret is actually two secrets. But they’re related. One is good news and the other is bad news.
The good news
Let’s say you want to become a great cook. How would you do it? Take a cooking class. Read cookbooks and food blogs. Ask friends to share tips and recipes. Watch food TV. Learn about obscure ingredients and techniques. Cook every day.
It’s the same if you want to be a great tennis player or pianist or surgeon. Like Malcolm Gladwell says, you’ve got to put in those 10,000 hours.
So let’s apply that idea to investing. Let’s see…if you want to be a great investor, you should swap stock tips with friends, watch CNBC, learn about obscure derivatives, read corporate annual reports, and trade stocks every day.
Wrong, wrong, wrong. This is secret number one: great investing is simple. The harder you work at it, the less money you’re likely to make.
It feels wrong, but it’s right: lazy investors do better than active investors. Great investors buy cheap stock and bond index funds with every paycheck, rebalance annually (this will be covered next week), and ignore their investments the rest of the time.
They ignore scary economic news, bubbles, and manias, because they know that they have no control over these things and can’t predict when they’ll begin or end.
Time and patience generally pay off for investors. As William Bernstein puts it in his great new ebook, If You Can: “There’s nothing more reassuring than being able to say to yourself, ‘I’ve seen this movie before (or at least I’ve read the script), and I know how it ends.’ ”
The bad news
That’s the good news. I hid the bad news away inside it, the way my mom used to get me to swallow pills by embedding them in a spoonful of ice cream.
It’s that pesky phrase, “with every paycheck.” Secret number two: Great investors are great savers. If you save a big chunk of your check and do it consistently, it’s hard to lose in the long run even if your investment performance is mediocre.
If you don’t save enough, you’ll lose no matter what. Let’s turn it over to Bernstein again: “Even if you can invest like Warren Buffett, if you can’t save, you’ll die poor.”
In other words, the other key to being a great investor is the hardest thing in finance: spending less than you earn. It’s hard because of temptation, and because of circumstance.
How do you spend less than you earn when you get laid off?
The answer, of course, is to save even more of each paycheck to smooth over the inevitable personal financial crises.
How much? If you’re in your 20s, 15% is probably enough. If you’re in your 30s, make it 20%.
These are rough guesses: I don’t know how much debt you have or how you want to live in retirement. Yes, that’s a royal buttload of money. I said this was the bad news, right?
Really, that’s it? Honestly, I hate this. I wish the secret of great investing was to buy whatever Jim Cramer is talking about when he makes a certain hand gesture, sell it the next day for a a 12,000% profit, and retire next week.
Is anybody honestly surprised that it doesn’t work that way? Let’s end on an upbeat note. Because investing is simple, it doesn’t take a lot of your time. Great investing doesn’t require squinting at the multiple screens of a Bloomberg terminal or sneaking peeks at your stock positions on your phone all dya.
(I recently read a book about stock trading that—no joke—had a chapter about how to configure your desk and computer at work so that your boss won’t catch you day-trading.) That time you save by not being an active investor? That’s your 10,000 hours. I recommend learning to cook.
You’re going to want to thank the guy who taught you the secret of investing, and I’d rather come for dinner than sit through your piano recital.
No offense. Next week: How to stay involved with your investments…but not too involved.
“How to Start Investing: Part 2” originally published by Matthew Amster-Burton