People new to the world of finance are often blinded by all the options available for investing in the stock market:
– Direct investments in stocks – but which ones? Growth? Value? Invest far and wide? Or only in a few?
– Trading stocks or options – how to value and trade? Fundamental Analysis? Technical Analysis?
– Investing in packaged products – Mutual Funds? Index funds? ETF’s? REIT’s?
I wrote a post recently that summarized these options; here I simply want to add a little more info …
Investopedia Says:
The building of a factory used to produce goods and the investment one makes by going to college or university are both examples of investments in the economic sense.
This means that the true definition of an investment is something that makes a little money now, or more likely a lot of money in the future.
Therefore, while I say that there are three sensible ways to invest in stocks, there are only two investment methods recommended by Warren Buffet:
1. Buy and Hold low cost, diverse Index Funds (check out Vanguard‘s web-site, and others) – this is a long-term, low risk (if your holding periods are 20 – 30 years) strategy that can help you fund a normal retirement.
“By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals” W. E. Buffett – 19932.
2. Invest in a FEW stocks in companies that are (a) undervalued (b) have a large margin of safety (c) that you love and (d) are prepared to HOLD until the rest of the market decides that they love them, too (at which point you can cash out or keep holding for the long/er term). “I never attempt to make money on the stock market … Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” W. E. Buffett
Speculation should not be considered purely a form of gambling, as speculators do make informed decisions before choosing to acquire the additional risks. Additionally, speculation cannot be categorized as a traditional investment because the acquired risk is higher than average.
So, take Warren’s advice: unless you have a strong reason to do otherwise, stick to one – or both – of the only two ways of investing in stocks and, over the long-term you are very likely to outperform all but the luckiest of those speculators out there …
Warren is certainly one of the best investors of all time, but there are many who he would consider “speculators” who beat his approx. 23-24%, people found in books like “Market Wizards”.
It seemed like each different individual in the book had their own “system” and produced outstanding results even over a 10-20 year period. So maybe the secret is finding the system (that you created) that works for you.
@ Joshua – Absolutely; Warren is not the be-all-and-end-all of making money. Just recognize the difference between being in the ‘business of speculating’ (a Making Money 201 possibility) and ‘optimum investing’ (a Making Money 101 and 301 requirement) … some of the best in the ‘business’ have indeed succeeded over long periods but most have gone by the wayside …
In other words, a specularor or trader (like me) needs to have a definable and measurable “edge” or they should buy the market portfolio. There are more sophisticated ways of doing this than just buying a US index fund at Vamguard or wherever. To start with they should be much more diversified than this, do some rebalancing and use low cost leverage in stocks or real estate where available so they can add maybe lower returning diversifiers to their portfolio.
@ Moom – Before I comment, check out tomorrow’s post (and, possibly the next day’s) and let me know your thoughts.
So what do you think was the difference between the best in the ‘business’ and those who have gone by the wayside?
@ – Josh. Good question … speculation v investment. The ‘lucky’ speculators treat it as a business and know when to quit – using their own money … then they’ll hang up a ‘hedge fund’ shingle and speculate with other people’s money and make 2% of funds under mgt + 25% of fund profits (with no downside risk … sweet!).
Thanks AJC, This money making 201 opportunity sounds alot like Warrens first limited partnership and we both know where he ended up.
Trading is not as easy task so it is important to learn to trade stocks. It will fail if you are not willing to put in extra time to study and learn.
You have to invest the lump sum. Dollar cost averaging makes no sense on the lump sum unless you know the future. Maybe you do want to diversify the sum, but you don’t want to hold on to it.
“then they’ll hang up a ‘hedge fund’ shingle and speculate with other people’s money and make 2% of funds under mgt + 25% of fund profits (with no downside risk … sweet!).”
The best hedge fund founders (e.g. Soros, Simons) manage their own money as well as investors’ money and kept most of their net worth in the fund. These are the hedge funds that make sense to invest in too as the manager’s interests are aligned with the investors. Of course most of the best hedge funds are closed, though good funds of funds often can invest in some of them.
@ Josh – Good Luck!
@ How to Trade Stocks – And, you’re just the person to teach ’em, right? 🙂
@ How to Invest – I’ll leave you and How to Trade to duke it out! 😉
@ Moom – Why pay a middle man? Invest in what YOU know best … that could be a specific investment class/strategy; profession; talent … i.e. yourself! It’s also what Warren Buffett recommends.