Master the Stock Market in 8 Minutes or Less
It’s January of 2018. Frost hangs in the 50º Los Angeles air. It might be even colder, but no one is brave enough to find out. We’re all bundled up in our apartments by the fake fire streaming on YouTube, trying to occupy ourselves without acquiring Cabin Fever in the process.
I was taking the opportunity to read up on how to make more money without quitting my day job at the time. My pay was fine, but I knew it wouldn’t take me where I wanted to go: buy a house, invest for my future kids’ college tuition, travel, retirement, etc. I waded through a mountain of books and listened to a year’s worth of podcasts on investing, side hustles, and the magic of compound interest (article forthcoming). Out of all I read and heard, the one thing that struck me was that my notions of the stock market, how it worked, the best way to invest in it— which I assumed to either be overly simplistic or else wildly mistaken, perhaps both — turned out to be dead right.
This is no credit to me. I’d simply heard enough people make the same comment enough times on NPR, and it turns out that enough of the experts I found to be the most trustworthy happen to unreservedly agree with them. Interesting enough, the received wisdom I’d internalized from these experts along the way is really just one central idea. The fact that it is only one concept (though we’ll break it down a bit), all alone in a sea of information, is itself part of the Big Idea.
OK. No more build-up. Here we go. Are you sitting down?
Here’s the secret to successful investing:
No one can beat the stock market.
Is your heart racing? Sweat glands activated? Arm going numb? Feverishly searching for a soft place to lie down, lest you faint and crack your head open? Unlikely. Truly, it’s not very exciting. It is, however, what I and many (actual) experts believe to be the truth about smart investing. For a number of reasons that we’ll dig into momentarily, there is absolutely no reason to try to beat the market.
What exactly is “beating the market”? “Beating the market” is the idea that picking and choosing which stocks you should buy and sell on any given day will make your overall returns better than the returns of the stock market as a whole. In other words, “market beaters” (mythological creatures) believe that you would make more money in the long run by being selective than by putting your money in everything at once. In order to do this, you’d need to be able to predict the future. Cue Man of La Mancha.
Instead, the savvy investor should put their money in the entire stock market. It may sound counter-intuitive at first, but think of it like roulette. There is a 100% chance the ball will land on one of the numbers, so betting on nearly all of them makes your chances of success much higher than simply trying to guess the lucky one. For the market, this means that you don’t have to pick a single stock over any other. In other words, you can return that crystal ball you bought at Target when you went in last week “real quick” to “just pick up some toilet paper”. Thanks to modern investing, you can do this quite easily by investing in something called an index.
An index is a catalogue of stocks. It’s basically a list that shows all the stocks that the index has decided to follow (the term commonly used is track). For illustration, let’s create our own index. We’ll call it the Soda Stock Index. It will track the stocks of just two companies: Coke and Pepsi. Those two stocks would be on our list, or our index. If we were spinning a roulette wheel, it would only have two giant spaces, one for each of our stocks.
If you wanted, you could choose to invest in shares of Coke over Pepsi then hope and pray that you picked correctly. With our Soda Stock Index, though, you could have both in your portfolio at once, making your odds of positive return even greater. While this scenario is overly simplistic, it represents a case in point of a broader principle: the more stocks, the better.
The wider the range of stocks you have, the greater your chances of success. In order to do well in the stock market, you should buy and hold many stocks, so that your chances of success increase. In fact, you should buy and hold as many stocks as possible (to a certain point). In our Soda Stock Index, if Coke shoots way up, but Pepsi slips down, you have might broken even. If you had gone it alone and only bought Coke stock, you’d have gotten lucky. If you had only bought Pepsi, though, you would have lost money (at least in the short term). This is why having more stocks in your portfolio (your own kind of catalogue) is so beneficial.
“Don’t look for the needle in the haystack. Just buy the haystack.” — Jack Bogle
The next step in accepting the market as the ultimate winner, and hitching your wagon to its star, is understanding the value of time. Importantly, timeframes in investments function best in terms of decades. That means that days, weeks, months, and even whole years are fairly hollow indicators of success.
Jack Bogle, the founder of Vanguard who recently passed, said as much. He believed that daily stock price fluctuations were meaningless. A stock price can swing several percentage points one way or the other in a single day, and the next day, it will do it all over again. Bogle was also the creator of index investing for the masses (like our hypothetical Soda Stock Index, but on a much larger scale; hundreds or thousands of stocks can be held in a single index fund). Rather famously now, he once said, “Don’t look for the needle in the haystack. Just buy the haystack.” Sage advice from someone that many investing experts refer to as a genius.
Timing the market is like guessing when a firefly is going to light up on the back porch.
The longer you hold stocks, the better. Beating the market is so difficult to do for a long period of time because stock pickers are forced to time the market. Timing the market is like guessing when a firefly is going to light up on the back porch. One of them might have lit up every five seconds for a minute straight, but that doesn’t mean it will continue to do so at that rate for all eternity.
(Side note: This is why Bitcoin and other cryptocurrency strategies are not actually investing: they’re gambling. So long as you know that’s the case, throw your money at it. If, however, you’d prefer to make money the time-tested way, go with low-cost index funds.)
Stocks are the same way. There is no formula for predicting stocks, no way to measure a stock’s past and surmise its future. Anyone claiming to be a stock market oracle is likely trying to sell you some of his or her best snake oil, too (or a second-hand crystal ball). The longer you hold stocks, the more likely you are to come out all right in the long run. The history of the stock market will not foretell its future, but the entire history of the market itself is a (so far) never-ending tale of moderate gains.
In fact, the S&P 500 (an index cataloguing 500 major stocks) has produced an average rate of return of about 7% every single year over its entire history. What’s more, this number is already adjusted for inflation, meaning that an individual’s actual gain on their investment is 7%. That’s pretty remarkable.
Picking your stops by flipping a coin would be a better route than actively trying to beat the market.
On the other hand, for those “investors” relentlessly trying to time and beat the market, the results have been less than stellar. In their obituary for Jack Bogle, The New York Times wrote:
Since 1984, less than half of the actively managed mutual funds that invest in a broad array of American stocks have outperformed the Vanguard 500 Index Fund, one of the world’s largest, with more than $441 billion in assets under management.
Less than half. Those aren’t good numbers. Would you really want to invest your money with someone if they told you the chances were less than 50% that you would get a better return than simply investing in the whole market? To put it bluntly: picking your stops by flipping a coin would be a better route than actively trying to beat the market. That’s a pretty scathing criticism of active investment strategies (as well as of the cryptocurrency craze, as mentioned earlier). It gets even worse when you consider that most major investment companies charge a handsome fee to do all this less-than-stellar work for you and your hard-earned money.
How should you invest your money, then? Easy. By putting it into a low-cost index fund like what Vanguard offers, or by letting a low-cost investment company do it for you. Initially, I did it all myself, but as of late I’ve taken the latter strategy. The company I use is called Wealthfront. It is helmed by Burt Malkiel, a Princeton professor, former dean of the Yale School of Management, and economic equal of Jack Bogle, if ever that could be claimed (they worked together at Vanguard for nearly three decades).
Malkiel wrote A Random Walk Down Wall Street, which is the single greatest book on investing that I’ve read. He espouses all the best Bogle principles, and the Wealthfront investing strategy is outlined clearly on their website and in his book. If you get a chance to read it, it might be the best thing you ever do for your money.
Investing with Wealthfront (or a similar company, such as Betterment or Twine) gives you the peace of mind that your money is going to work for you as hard as you work for it. It also allows you the freedom to simply let the investing happen on its own, without all the worry of if/when to buy/sell this/that stock.
Of course, if you want to invest in other companies that you feel strongly about, go ahead! There’s nothing wrong with investing in businesses, organizations, industries, or even cryptocurrencies that you believe in. At the end of the day, simply make sure that most of your dollars are going to indexes, and the rest will take care of itself. That much is virtually guaranteed.
Notes: I am not affiliated with any of the companies listed, nor are any websites contained here affiliate links or promotions. If this status changes, I will update this page to reflect that. As mentioned, I invest regularly with Wealthfront. I have also used Twine. Betterment is a competitor to these two, which I have researched, but have not personally utilized.
