Warren Buffett has offered some simple advice for the amateur investor and stock picker that just about each and every one of us can follow. Amateur? Because the vast majority of us are nowhere near close to being financial wizards. We have enough trouble balancing our checkbooks and we don’t even hold a job remotely close to being in a finance-related field. We are teachers, managers, laborers, and engineers.
With the above realities in mind the question then becomes, can the average person do a good job with investing in the stock market and picking stocks? The answer, simply put, is that it does really depend but with some time and effort it can be possible!
Warren Buffet has over 60 years of experience and invests full-time. Historically, Mr. Buffett has insisted that investing doesn’t require a high IQ, but it does take some knowledge and experience to recognize what a good, if not great investment may be. Of course, he also has several advantages that the average person doesn’t have yet, his basic strategies are still available for use and can apply to us all.
Mr. Buffett has outlined two different choices and sets of instructions for each for us non-professional investors to follow.
Choice A) If you lack knowledge about the stock market and are short on time, these are two very simple and easy tips that you can implement and follow starting now:
- Put 10% of your investment monies into short-term government bonds. This is money that can be accessed quickly and easily, but isn’t “rotting away” in a checking or savings account.
- Put the remaining 90% of your investment money in a low-cost index fund. While this isn’t the most sexy or exciting advice, it makes a lot of sense. Few managed funds are able to match the expense-adjusted results of an index fund over several years. Plus, the relatively high expenses and the possible errors of an investment fund manager can end up being too much of a disadvantage to managed mutual funds.
The above advice is the exact same advice that Mr. Buffet has left for the trustee that will administer his wife’s trust. Assuming that he loves his wife, and we are assuming that he does, it is probably good and sound advice for the rest of us to follow too! It really doesn’t get much simpler than this. It also requires very little time and attention on your part and let’s face it, for most of us, time is not a luxury that we have in any abundance.
Find more details about investment and mutual funds here.
But what if you have the time or are willing to make the time and you prefer to be more active with your investment strategy? The above advice is great for those of us that want our investing to be as simple and easy as possible. But what advice does he have for those of us that would like to take a little more “hands-on” approach with our investing?
Choice B) Mr Buffet does have some advice for those of us that prefer to pick our own stocks and investments as well:
1. Familiarize Yourself With The Ins And Outs Of Stock Analysis.
Mr. Buffett has frequently given this exact advice to business students: It starts with doing your research and analyzing every single stock on the NYSE. Yes, you read that right – research and analyze every single stock on the NYSE. When the students reply in utter despair to this advice and complain that there are thousands of companies listed on the NYSE, Mr. Buffett’s no thought to it at all response is to basically suck it up and “Start With The A’s.”
- What can be the justification for such an enormous undertaking? Mr Buffett’s answer is quite simple. He has stated that it should be much easier for you to recognize the good companies and investment opportunities from the bad ones after you’ve researched a few thousand of them. It makes sense, right? Knowledge is power!
2. Consider The Margin Of Safety When You Invest.
Invest in companies that are available for a discount relative to the true value of the company. This gives the investment in a stock a price buffer. The greater the margin of safety, the greater the potential upside. And then of course, the potential downside is also greatly reduced.
3. Invest In Businesses, Rather Than Markets.
Buffett doesn’t recommend investing just because a certain type of economy exists. At the end of the day, it’s the quality of the underlying company that’s most important. The economy rarely enters the picture.
4. KISS – Keep It Simple, Sunshine!
According to Buffett, as has already been pointed out, being of average intelligence and utilizing some common sense is all that is necessary when it comes to investing. Stick with businesses that are easy for you to understand. It’s easy to understand how a grocery store earns its money. Biotech companies, on the other hand. are a little more complicated. If you can explain what a company does to your mother and she gets it, then you are probably okay.
5. Take Information With A Grain Of Salt.
Buffet once said, “Never ask your barber if you need a haircut.” After-all, at the end of the day, who really gains benefit if you follow your barber’s or therefore a broker’s advice? Do not necessarily ignore the information that has been offered, but dig deeper, find out as much as you can yourself, and always make sure to consider the source. Do not take information at face value.
- Unfortunately, for many of us, the more “mysterious” the source, the more credibility we tend to project onto the source. You may doubt your friend, or even a professional, but for some unknown reason, you convince yourself that the odd man on the bus certainly must know what he’s talking about.
Active investing does require you to do your due diligence and to know what to look for. With proper research it is possible to have success. The question for you is, do you have the time to do it right? If you do, then great and have at it!
For the rest of us, Mr. Buffet suggests an index fund for all of us armchair investors. Which, by the way, for all of you wanna be Gordan Geckos out there, he is more than likely referring to most of us, if not all of us.
For those of you that do relish the time spent and energy required to self manage their investing, it is possible to end up doing well on your own.
Section Conclusion
Regardless of how you handle your investing, it’s important to put in the necessary work to find the solid investments that are right for your investment needs.
In case you missed it, if you’re short on time (once again, most of us), then the index fund solution is probably your best option.
Moving forward, once the base needs of your finances are looked after – your emergency fund and your insurance needs are in place – getting “extra” money out of a bank account and into the stock market should probably be well worth your while. Whether or not you take a totally active and involved approach or take the “armchair investing” approach, financially you should better off with stock market investing when compared to leaving your money in a savings account.
The point is this: If your situation allows for it, learning more about investments in general and getting your money involved in investing should be a financial planning goal for all of us, regardless of which investing approach you choose to take.
Why Index Funds Might Be Your Best Stock Investment Strategy
Are you confused by the many options available to you when investing in the stock market? One of your options – investing in mutual funds – brings you the benefit of spreading your risk over many different stocks, so you don’t end up “putting all your eggs in one basket” and thereby risk losing your entire basket.
Mutual funds in general are a great investment vehicle for those of us that want to be involved in the stock market but do not have the time to actively trade, and may not have a lump-sum amount of money available to start to “play” with. Even if we do have the time and the money, considering the risks involved with investing in the stock market, mutual funds allow for the risks to be minimized.
Simply put, investing in funds instead of directly investing in stocks is an easy, mostly hands-off, diversified, low-cost way to have your money work for you by still being invested in the stock market.
Within the realm of mutual funds, there is one type of investment fund that performs as well as a standard market index does – A standard market index measures various parts of the market as a whole – and those funds are index funds.
What are index funds and, more importantly, are they a good investment for you?
What Is An Index Fund?
An index fund is a mutual fund whose portfolio matches a stock index.
Investing in an index fund is like owning a little bit of every stock in that index. So the market exposure is very broad and therefore the risk relatively minimized.
For example, a United States based index fund might match the stocks in one of these indexes:
- Dow Jones Industrial Average – tracks 30 of the largest publicly traded firms
- Dow Jones Wilshire 5000 – tracks all USA based publicly traded companies
- S&P 500 – tracks 500 Large Cap corporations
- AMEX Composite – tracks all the stocks on the American Stock Exchange
- NYSE Composite – tracks all common stocks on the New York Stock Exchange
- Russell 3000 – tracks the largest 3000 U.S. companies
The above indexes are widely used for index funds; however, there are also several more indexes in the US, so you may find an index fund matching another market index as well.
There are index funds, much like mutual funds, that are based on:
- Company size and capitalization. Index funds that track small, medium-sized or large companies (also known as small-, mid- or large-cap indexes).
- Geography. These funds focus on stocks that trade on foreign exchanges or a combination of international exchanges.
- Business sector or industry. Funds that focus on consumer goods, technology, health-related businesses, for example.
- Asset type. Funds that track domestic and foreign bonds, commodities, cash.
- Market opportunities. Emerging markets or other nascent but growing sectors for investment.
Interested In Foreign Investing?
If you’re interested in exposing your investments into foreign markets outside of your home country, as listed above, there are also index funds which match international or country specific indexes.
Pros And Cons Of Index Funds
Some common criticisms of index funds are that they can never beat the market (true) and they are not professionally managed (also true, because the index determines which stocks to buy).
On the flip side, they never do worse than the market. Also, the fees for management expenses are minimal because you don’t have a fund management team to pay. Additionally, the portfolio turnover is usually also quite low.
There Are Still Some Fees To Consider:
- Expense ratio. Nothing worthwhile in life is free. Even though there are no active fund managers looking after an index fund, there are fees for maintaining the fund. The main costs are subtracted from each fund shareholder’s returns as a percentage of their overall investment.
- Transaction Costs. What are there fees for the buying and selling of shares in the fund.
- Tax-cost ratio*. Owning a fund may trigger capital gains taxes if the fund is held outside tax-advantaged accounts like a 401(k) or an IRA. Taxes are not fun to pay at anytime, but in the case of an investment fund, taxes deducted out of your investment will affect the returns.
*Regarding the Tax-Cost ratio: Any investment that grows in value over time can have capital gains tax implications. The tax-cost ratio is not necessarily exclusive to investment funds or index funds.
Although not necessarily as much about the fees there are other costs to consider. There may be minimums that you would need to take into consideration:
- Investment minimum. How much money do you need start your fund? This amount will vary from company to company. There are some funds that offer no minimum required to start investing. However some funds can have an amount as high as a few thousand dollars to start. If there is a minimum, once you’ve met that amount, most funds allow investors to add money in smaller amounts and with regular periodic deposits, such as a monthly investment plan.
- Account minimum. This is different than the investment minimum. Once you are in, you may need to maintain a minimum balance with the company.
Mutual funds in general and including index funds as well, are usually only traded once per day at the end of the day. This means that no matter when an offer to buy or sell is placed on a given day, the transaction is only processed at the set time for that day. So, if it is your investment thing to time the market during the day, mutual funds as an investment to capitalize on the by the minute market fluctuations is drastically limited, if not completely wiped out.
Index Funds Vs. Managed Funds
Interestingly, even though index funds never beat the market, at one time, index funds outperformed 97% of the managed funds over time.
Sound impossible? How can a professional money manager consistently do worse than the equivalent of simply buying and holding every stock available?
Not so long ago the New York Times published a story with research showing that for a managed fund to break even with the market, it has to outperform the market by 4.3%. Most financial experts concede that this is highly unlikely to be accomplished, and at the time, the research supported that conclusion.
At that time looking back over the previous 20 years, it was found that only 13 out of 452 domestic mutual funds met that criterion. That’s less than 3 out of 100 when you include the fees and expenses!
But don’t count managed funds out of the picture just yet!
In today’s current global situation and market conditions, managed mutual funds have faired better than they were doing at the time that the New York Times article was written.
The question remains for most of us, which fund type is better for us as regular people wanting to maximize our returns for our investment dollars?
The short answer to that question is that it may depend on the market type and investment fund type that you would choose to invest in. Possible market and investment types to consider include US versus foreign equity funds and equity versus fixed income funds.
Typically index funds have done better for US equity stock indexes than the similarly invested managed funds have. However, managed foreign equity funds have generally performed better then the US domestic equity index funds have. Perhaps then, Index fund domestically, managed funds internationally?
Managed fixed income funds have also generally performed better than their non-managed index fund counterpart.
But do not take our world for it! Do your own research and as in all things in life, you must consider the reality of who you are as an investor and of your own personal situation. It is your money and you as an investor need to consider your investment preferences and level of risk that you are wiling to take on.
Choosing to be a little more active of a fund investor, if you are willing to make the time to research and then monitor your investments, then you may be able to see better returns with managed funds or even with individual stock picking. If you prefer the “set and forget” approach to your investing, then, as Mr. Buffet has suggested, index funds may be the best option for you.
How To Choose An Index Fund
Selecting an index fund is actually much easier than deciding to invest in index funds in the first place. The management talent to run an index fund is usually not in consideration, and there’s very little difference in performance between different funds based on a given stock index. Therefore, the main consideration that usually matters when choosing an index fund are the fund costs.
It can be said that buying shares in an index fund is like buying a bag of flour: The label on the outside of the package may be different but it’s essentially all the same on the inside, except for the price.
Consider these points when choosing an index fund:
- Expense ratio. You’ll find this cost ratio in your materials that give the details of the fund. It helps you compare this company’s fees to those of other companies.
- Transactional costs. The expense ratio doesn’t capture the transactional fees, so be sure to look at the trading frequency of the fund in question.
- Check to see that they aren’t buying and selling too frequently. Buying and selling stocks costs money, so your costs will go up if this company buys and sells their stocks more often than other companies with this same type of index fund.
- Compare the various index funds with the index you wish to follow to get an idea of what’s typical.
- Which index will you follow? There are numerous indexes in which you can invest, including small cap, international/foreign, bond, and large cap. Study the descriptions of various indexes to determine one that fits well with your risk tolerance and investment goals.
- Retirement fund options. While you may not have a lot of options with your 401(k), there is typically an index fund option. And you have a lot of freedom with your IRAs to invest as you see fit, including in these funds.
Conclusion
If you’re tentative about investing in index funds because they never beat the market, remember that continually beating the market with any regularity is rare.
For most of us the real questions that needs to be answered is, “Do I even want to invest in the stock market at all?” (May we suggest that your answer to this question should be yes!)
If your answer is yes (again, it ought to be yes), then as long as you carefully research the mutual fund costs and fees, the historical data of a fund and the track record of the fund managers, and then compare that to comparable index funds, you should be able to find the stock investment strategy that works best for you. Also, after completing the same research, you just may come to the conclusion that index funds are the all-around best solution for your investment needs.
Investment funds can offer a distinct advantage when following a constant monthly investment strategy where you are investing the same amount of money month after month. By following the monthly investment strategy, Dollar Cost Averaging (DCA) is a great way to still potentially profit from market downturns. The benefits that you can gain from DCA is a key part of the monthly investment strategy that is not available with a one-time lump-sum investment. With DCA even in Bear Markets you should be less stressed since DCA is working to gain you benefit – Depending on your timing requirements, soft markets can actually be of extreme benefit to you once the market recovers.
Do not let your fears stop you from reaping the benefits of investing in the stock market. Historically, over time, the stock market has outperformed the returns compared to leaving money in the bank. Investment funds, active or passive, are a great way to minimize the cost and the risk of stock market investing. And index funds are a great way to further minimize those factors and still benefit from having your money engaged in the stock market.
If needed and as always, speak with professionals, get advice and do your due diligence. Do your own research for sure, but do figure it out for yourself and make a wise investment choice that is best for your and your situation.
BAM! Be A Man. Do The Right Thing. Take Care Of Yourself And Your Money
BAM! Be A Man. Do The Right Thing.
Be The DtRTy Guy!
