5 Rules for Stock Market Investing
TL;DR: Investing in the stock market is simple, but not easy.
Follow these 5 rules, and you’re sure to become an investor that Warren Buffet would be proud of. Then why isn’t it easy, you ask? Because you have institutional and psychological forces working against you.
The money management industry has been built to funnel money from your pockets to theirs. Every $10 trade commission you pay is $10 fewer of investment gains.
And our emotional brains are working against us! We are overconfident in the face of randomness and our aversion to losses leads us to bad decisions.
These 5 common sense rules will keep you on the right path…
1. Start Investing NOW Because of Compounding Interest
The biggest investment mistake is not starting today. If only I had a dollar for every time a 20-something has told me: “Eh…I’ll figure it out when I’m 30.” And you know what 30-somethings say? “Oh, I’ll definitely have that stuff figured out by my 40's.” In fact, delaying investing has an exponentially negative effect on your future wealth.
Take a look at the S&P Composite Index over the past 90 years:
Equity markets grow over the long-term. The US equity market has historically returned 10% per year (including dividend reinvestment).
Let’s use the Future Value Formula to determine how much money you’re sacrificing by not starting now. We’ll assume that you retire in 40 years, start investing $10,000 today, and can earn 10% per year.
40 years from now, your portfolio is worth $451,984 due to compounding interest. But what if you wait 5 years to begin? Well in that case, your portfolio is worth: $280,694.
Waiting 5 years to start investing costs you: $171,000!
2. Diversify Your Portfolio
Diversification means not keeping all your eggs in the same basket. When it comes to investing, it means that your investments should be spread across geographies and in different asset classes.
Asset class is a term that just means a type of investment. Stocks (AKA “common equity”) are one asset class; government bonds are another. Each has its own properties. A good way to sort them is by the underlying “issuer” — the entity that pays the investor:
Geography is the second axis of diversification. The goal is to minimize your risk in case something economically terrible happens in one country. By spreading your investments globally, into developed and emerging markets, you also help prevent home bias. Home bias is the tendency to allocate too much of your wealth to investments in your domestic market.
Here are examples of prominent developed and emerging markets:
It’s nearly impossible to predict which asset classes and geographies will perform the best. Instead, we own a diversified basket so that the winners and losers balance each other out. This reduces portfolio volatility, and is the cornerstone to Harry Markowitz’s Modern Portfolio Theory:
“A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies.”
Note: At Commandiv, we recommend a diversified portfolio personalized to you and your risk tolerance, automatically.
3. Minimize Fees
As Warren Buffett once said, “the greatest enemies of the equity investor are expenses and emotions.” Simply put, every dollar you pay to financial middlemen lowers your returns. These fees take many forms: commissions, management fees (in mutual funds and index funds), advisory fees, and taxes.
Commissions are the price you pay your broker to place a trade. Online brokers charge up to $10 per trade, while “full-service” human brokers can charge you closer to $100. (Note: if you’re a client at Commandiv, you can trade all you want and never pay commissions!)
Management fees are charged by mutual funds and index funds. They’re charged as a % of your investment and are typically removed from your dividends — you’ll never see them itemized on a bill. Be careful of these fees! Some mutual fund managers will slyly charge 1.0–2.0% per year for “the privilege” of investing in their fund. On the other hand, index funds charge management fees as low as 0.03%!
Advisory fees are charged by investment advisors to help manage your wealth. Human advisors typically charge 1.0% of your assets per year, whereas digital advisors frequently charge less than half a percent. No matter what, demand Fiduciary Standard treatment from your financial advisor! Otherwise, he is likely recommending you investments that pad his pockets the most. (Note: Commandiv is 100% dedicated to the Fiduciary Standard — we always put our clients’ best interests first…as every advisor should!)
Taxes are unavoidable, but can be minimized. The best way to reduce investment taxes is to buy-and-hold for the long-term, at least for periods greater than one year. When you hold for greater than a year, your capital gains tax rate decreases substantially. If you could buy and never sell, you could perpetually defer Uncle Sam’s capital gains tax.
4. Buy-and-Hold for the Long-Term
At every market downturn, Average Joe investors pull out their money because they’re afraid to lose more. Then they miss the market rebound.
In market rallies, Average Joe investors get greedy. They continue to double down and borrow money to invest more. Then they get burned when the bubble pops.
In short, don’t trust your emotions when investing.
So what can we trust? Well, we can trust the long-term rise of markets over time (see: Rule #1). Even if you invested all of your money on August 31, 2008, just days before Lehman Brothers declared bankruptcy and the Financial Crisis kicked into full-gear, your investment would now be up 210.9% (an annualized 14.6% return)!
Ben Graham, Warren Buffett’s mentor, wrote:
“The real money in investment will have to be made — as most of it has been made in the past — not out of buying and selling but of owning and holding securities, receiving interest and dividends and increases in value.”
5. Dollar-Cost Averaging Increases Returns
Dollar-cost averaging is the act of doing two things: 1) set up a recurring deposit into your brokerage account, and 2) regularly invest that cash along your target portfolio. The beauty of this simple strategy is that it allows you to reduce your cost basis per share, because you’re buying more shares when stocks are down and fewer shares when stocks are up!
Let’s see how this works through an example. Let’s say you deposited $1,000 each month to buy stock in Cabot Oil & Gas Corporation (COG).
Because prices have generally declined, we’ve been able to buy more shares each month since October. These additional shares were purchased at lower prices. If the stock price recovers to $25.71, then our entire COG position will be up 13.2%! Dollar-cost averaging is a great way to beat your emotions and capitalize on lower prices.
We Can Help!
We built Commandiv as a smarter stock-trading platform with personalized trade suggestions to make intelligent investing easier and quicker. We help you achieve your target portfolio with low-fee ETFs. We also charge zero commissions, because there’s no need to pay $10 for every trade!
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If you’re interested in a smarter stock-trading platform, check us out at: commandiv.com. Feel free to email us at founders at commandiv dot com.
Edited by Tom Goldenberg
