The Best Way To Buy Stocks Is To Not Buy Stocks.
The smartest minds choose a better, easier path
Yes, you read that correctly; For most people, the best way to invest in stocks is to not buy individual companies. 80% of the world’s fund managers fail to beat the market (meaning to outperform the S&P 500 index), so what chance does a novice or beginner have of getting anywhere close to keeping up with the averages? Even Warren Buffett himself (widely known as the world’s most successful investor and 5th richest person in the world) has failed to beat the market over the last 5–10 years.
You may think ‘well yes, but an individual investor is more interested in long term returns than the quarterly results that professionals are measured by, so surely a well picked portfolio held for years will beat the S&P?’ Well, Buffett is famous for his buy and hold philosophy, in fact, one of his most famous quotes is ‘our favourite holding period is forever’, and of late even he has failed, so is it really worth the risk for the average investor?
To buy individual stocks you must do your homework. You must read the quarterly reports, and understand them. You need to have a good understanding of accounts, what’s good and bad, and you must read what’s there, not what you want it to say. Knowing what not to buy is far more important than buying the right stock; Walking away will save you more money than what you make when you get a stock pick right. You need to understand the company thoroughly, so much so that you could explain to a friend or even write in detail about why you have decided to put your own money into this company, and most importantly, why you think that the company in question will grow faster than the overall market. If you cannot do the latter, then you haven’t done enough work to warrant buying the stock.
The Easier, Better Way
Chances are, you won’t beat the market. So ‘if you can’t beat them, join them’. Over the last few decades, investing has had many developments that has made life easier for the small-time investor; The internet has made buying stocks much cheaper than a traditional broker, meaning you don’t need to invest vast sums of money to absorb large brokerage fees, and the invention of the ETF (Exchange Traded Fund) has meant that investors both new and experienced can gain exposure to a large array of stocks, bonds or commodities with very little outlay and no individual stock pickings.
So what is an ETF?
An ETF is a way of investing in a wide range of stocks or commodities in one low cost package. So how does that work? Well imagine gold; buying gold yourself is expensive. You have to buy it online or from a shop and likely pay a premium, you then have to pay an annual insurance or even pay people to guard it if you’re fortunate enough to own that much. You’ll then sell it to someone who will want to sell it on for a profit, and therefore receive less than the market value. Every step will diminish your return on investment, and therefore your capital gain will be significantly less than the price rise of the underlying asset.
The largest gold ETF (GLD) is effectively a company that owns $74 billion worth of gold, with its shares publicly traded on the New York Stock Exchange. What this company does is manage the gold, and pay for all of the insurance that goes along with it, but has no other business activity. The result; the share price of GLD moves with the exact same line as the price of gold, but the insurance and management costs are diluted between such a vast quantity of gold that it’s much cheaper than buying gold in your own right. The second great thing is that this ETF, like every ETF, is traded on the stock exchange, which means they are far more liquid than any other fund or physical asset. If you think gold will go up in price this week; You simply open the app of your broker on your phone and within seconds you own as many shares as you like of GLD, and at $179 per share, it’s possible to own even if you have a small amount of money to invest.
Now I don’t recommend using an ETF to trade, but even if you wanted to hold gold for 25 years, the ETF will be cheaper than owning physical gold, and lightening fast to sell when you decide that the time is right to exit.
So let’s get back to stocks. I started the story by telling you that you won’t beat the market, so don’t bother. Now you may think that that’s negative, that I can’t beat the market so obviously you can’t and I’m a sore loser. But let me ask you this; Do you need to beat the market? The S&P 500 has averaged a 9.8% return over the last 90 years, meaning that a $100 investment in 1930 would be worth $451,035.38 today, so why try and beat that? I’d be over the moon.
Let’s say you’re 25 and you want to put $500 away for retirement at 70; 35 years later at a 9.8% annual return you have over $33,500, simply by buying something and sitting on it.
The S&P 500 index is made up of, you guessed it, 500 companies. Specifically, the 500 largest companies in the US, diversified over every sector of the economy. Now owning 500 different stocks, with the correct number of each share to match the precise value of the index is pretty much impossible; You’d need millions of dollars and countless hours per day to get a portfolio to exactly track the value of the S&P. Thankfully, our good ol’ friend the Exchange Traded Fund is here to help; The SPY ETF is an ETF that has almost $300 billion in Assets Under Management, specifically designed to create the ultimate portfolio that holds the correct number of each stock to perfectly track the value of the overall market.
Above (although slightly out of date but you get the point), is a graph that perfectly illustrates how the SPY perfectly tracks the value of the market, and the best thing: it can be bought for $320.
Investing little and often in the SPY will outperform almost any stock portfolio over a long period of time, especially if, like me, you’re not a full time investor. So if you’re looking to do something productive with your savings that doesn’t require hours of your precious spare time, buy the SPY, sit back, and relax.
