I’m super excited to have a guest post from Riley Adams of Young and the Invested. Riley is a a senior financial analyst for a fortune 500 company. Besides having an impressive resume, he’s also a kick ass dude. I’ve had the great pleasure to chat with him quite a few times since I began this blog.
Get a beer, settle in, and prepare to have an abundance of financial wisdom dropped upon you!!
When it comes to growing your wealth and working toward financial independence, investing is an important tool. Through investing, you can buy assets which, hopefully, grow in value, whether it is a home, a retirement account, stocks, or bonds.
But how do you approach investing if you don’t have a background in it? Without much prior experience, it’s tough to say. There’s an ocean of information out there and sorting through it requires deliberate, thoughtful reflection when piecing together what you’ve read.
First, Invest in Yourself
This past summer, I attended a wedding with my wife and her family where my brother-in-law approached me with a conversation about investing. He wanted to know how he could replicate the performance seen by the world’s greatest investors.
Essentially, he wanted to turn a small sum of money into an account balance with two commas in quick fashion.
If only I knew the sure-fire way to make that path my own reality. If I did, we wouldn’t have driven to the wedding in a rented subcompact.
I cautioned him those investors are truly gifted and the exception to the norm. But what I then told him is the common trait these legendary financiers share: following a systematic and disciplined approach to investing.
I told him regardless of investing style, time-frame, or philosophy, they all have discipline, transact based on logical, informed thinking and do not let emotions drive their decisions. These are the most important elements required for investing success. But don’t just take my word for it, many folks seem to agree,,,.
The aforementioned investing strategies are merely a means to an end and come later. Any investor starting out should develop these core principles and learn to stick to them during times of good and bad.
Develop Your Investing Approach
As I explained this to my brother-in-law, I could see his disappointment in my not knowing any shortcuts to overnight investing success. However, we launched into a discussion around how he could develop his own disciplined investing approach by first becoming a student of markets.
Knowing that this discussion could become overly cumbersome in just one conversation, I decided to share only introductory steps.
Investing isn’t easy but, at the same time, it shouldn’t be seen as a frightening endeavor. If done wisely and consistently, investing can separate you from retiring comfortably at a reasonable age and working into your golden years out of necessity.
So, with that thinking, I will do the same here. Short of a formal education in finance, my five high-level steps for gaining familiarity with investing in the market are as follows:
1. Read a Lot About the Market
Sounds logical, right? You’d be surprised by how many people I’ve heard say they got into a stock simply because so-and-so recommended it.
This person winds up not doing a lick of due diligence before investing. This person didn’t know what was happening in the market, nor anything about the company beyond it being a hot stock tip.
To counteract this, I suggest first beginning by reading reputable sources that discuss markets (e.g., MarketWatch, the Financial Times, the Wall Street Journal, Reuters, Yahoo Finance, among others). As you read more, I suggest approaching every article with a heavy dose of skepticism.
This will make you more likely to piece together content from multiple sources and form your own thinking about markets and the companies in them.
As an exercise, take a moment to read this article about the earnings estimates for public companies. After you’ve read it, what were the main, salient points that stood out to you?
I found the following to be most important:
- Many investors seem to think lackluster stock market movement during this quarter’s earnings announcements indicates peaking corporate profits. When companies announce record earnings and markets barely move, it must mean expectations were high and future earnings don’t look to get any better.
- Analysts, or those people who follow stocks and publish opinions on them, disagree, and are increasing their profit projections at the highest rate in 6 years. This is where the skepticism should come into play. This conflict means someone is wrong, but who? Perhaps both are right and yet both are wrong. The truth likely lies somewhere in between.
- A growing economy and corporate tax reform have benefited companies but trade war activity makes for an uncertain outlook. To illustrate uncertainty, reporting companies have seen the most volatile trading in two years immediately after announcing earnings results. However, it appears this trading reaction could be the result of poor understanding of the effects of the recent tax reform legislation and clouds the visibility for accurately forecasting future earnings. Therefore, the volatility merely highlights poor forecasting abilities, not necessarily anything indicative of market direction.
- A lot of positive developments exist to push markets higher but looming risks serve to temper optimism usually present with such strong earnings growth. Bottom line: there doesn’t appear to be a strong case for a plummeting market but neither for a sustained rally.
As you read more pieces like this, reflect after each one and begin to piece together content from what you’ve read. Building this understanding won’t happen overnight.
2. Start Looking into Individual Companies
Naturally, you will come across individual companies. You should identify companies consistently performing well or making strides to improve.
I recommend starting your journey by researching five companies you admire (preferably in different industries) and cultivating ideas about the strategies of each firm, their competitive advantages, and the core value they provide.
If you don’t believe any of these items to be durable over time, I would suggest moving on. Recognize what sets these companies apart from their peers, the prospects for the markets in which they operate (e.g., growing market vs. declining market), and how the market values them.
Cast aside companies if you uncover something you don’t like. Don’t let sunk costs guide your thinking.
Ultimately, a stock represents a piece of a company, so sustainable profitability is an important factor.
You really want to assess how profitable these companies can be, because before you decide how much to pay for a stock, you need to understand how much money that company makes.
If the company makes a lot of money consistently, you will likely have to pay more to acquire the stock.
3. Take Action
At this point, if you’ve gotten a decent handle on the overall market’s activity and analyzed a set of attractively-valued companies you think stand out from the rest, it’s your time to pull the trigger.
There are a number of retail brokers you may use to invest in individual stocks (e.g., Interactive Brokers).
4. Continue Following the Companies and Markets
By doing your due diligence, you will be able to follow these companies and see if they continue to perform as you expect. If a company makes a decision you don’t agree with or think will adversely impact its value going forward, you might consider cutting your losses short and moving on.
5. Keep It Simple, Invest in ETFs
Investing is hard. It’s more art than exact science. By writing this step-by-step guide, my goal is not to simplify the act of investing. In fact, what I want to convey as clearly as possible is just how difficult it is to invest in individual stocks.
You might read other guides which attempt to simplify investing with platitudes and shallow advice like “buy low, sell high”, “be fearful when others are greedy and greedy when others are fearful”, or “keep your age as a percent in bonds”.
Investing is so much more than following some rules of thumb. Don’t think you have an investing edge when you really don’t.
If you don’t have confidence in selecting individual companies to outperform the market, another strategy is to use exchange traded funds (ETFs) to invest.
Personally, I use Betterment for most of my investing and the link above will grant you 90 days of free investing to use the service.
What’s better is to hold these ETFs for long periods of time and allow the last real-edge in investing to work its magic: time in quality investments.
When Investing, Doing Less is More
I think about smart investing in a way that minimizes mistakes instead of pursuing maximum gains. I don’t like taking on uncompensated risk.
A portfolio requires a healthy balance of risk and reward as well as exposure to many different investments. I keep the following items in mind when investing:
- Steer clear of all avoidable risks. Don’t take on unnecessary risk when the probability of a better investment outcome doesn’t exist
- Be cautious and highly skeptical of your conclusions and whether you feel you possess some edge. It is much more likely you don’t have one when compared to the deep pockets spending endless time and money seeking the next edge
- Minimize the number of times you touch your portfolio. High portfolio turnover in search of better investments often leads to negative consequences for your returns
- Avoid big mistakes. You stand to gain a lot more by doing nothing than thinking you have some edge (when you really don’t) and acting upon it
When investing, doing less is more. Therefore, I recommend investing through passive index funds.
Investing well can produce very rewarding experiences you share with those you love. For me, it allowed me to buy my first home and now to grow the assets necessary to purchase my next one together with my wife to start our family.
In general, developing your own disciplined investing approach based on rational, informed decision-making can lead to financial independence.
Learning how to invest wisely at a young age will have you maximize your youth by allowing compounding to work to your benefit. Do yourself a favor and invest in yourself by following these five steps to begin investing.