Before we jump into the actual theme, I want to answer a few questions:
What is it about investing in the stock market?
Investing in the stock market is not about picking stocks nor about timing the market. It's about constant contribution to your properly diversified portfolio. The market is smarter than you are, we cannot know which stock will perform better the next year and when is the best time to buy or sell it. Nobody knows where the market will be tomorrow and if somebody knew, he wouldn't have shared it with you. Who would share a milking cow? Since we cannot know it, we should aim for the market's average return (about 7%, look at the S&P 500 Index return in the graph below). We should also focus on our investment strategy and long-term investing.
Why invest when I can have my money in a savings account?
You can have money in your savings account, but due to inflation in 30 years, 100 euro will be worth much less than it is today. If you live in Europe, at best, your local banks can offer you 2% interest rate for your savings account without inflation. The real (inflation-adjusted) average annual market return is about 7% (see comparison graph below), so having money in a savings account is almost as effective, as having it under your pillow. The only difference is under your pillow money loses its value a little faster. But don't rush closing your savings account, it still can be useful for us in some cases, so from there we can proceed to our First Step.
Step I: Emergency Fund
Before investing you should have an emergency fund. That's where our savings account comes in handy. Emergency fund is a place with an amount of at least 3 (better 6) of your monthly expenses, where you can quickly access your money, if it's needed. The main purpose of having it is an emergency. So what is an emergency? I provide a few examples: buying a new TV is not an emergency, buying new furniture, because you are tired of your old one is also not an emergency, or building a pool in your backyard, because you want it right now is definitely not an emergency. Paying for car repair because you live 20 kilometers away from your job or you need to take your kids to school are emergencies. Also, if you have to pay a hospital bill, that's an emergency. Furthermore, if you lost your job and it takes some time to find a new one, that's an emergency. Emergency fund will help us not touch the money we've already invested and stick to our investment strategy. If you still don't have an emergency fund, it is about time to open up one. There is no point in starting investing without having an emergency fund. Emergencies can happen to everyone.
Step II: picking your investing platform
As we know, we should aim for the market average and it's in our hands to make it as cheap as possible. The fewer fees you pay, the faster your portfolio grows. I personally use Trading 212 platform. You can take a closer look at its pros and cons in our review or pick another one that fits you more in our review section.
Step III: building diversified portfolio
What if the market falls?
Market crashes periodically and there is nothing we can do about it, but don't be afraid, every time it recovers. People tend to sell their assets right after a crash and this is the critical mistake. As Warren Buffett said, 'Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.' This quote perfectly demonstrates how we should act during the crash: don`t be afraid of it, stay straight to your investment plan, and if you are courageous enough, increase the amount you invest fortnightly or monthly, furthermore, if you are young, you should be praying for market crash, so you can buy more for cheaper price. Buy and hold strategy allows us to buy cheap and sell dear, but we are not going to sell, at least till we reach our investment goal. As Warren Buffett said, 'Our favorite holding period is forever.'
Market Average Return
In order to have market average return, we need to have the whole market in our portfolio and one of the ways to have it is having all representatives of small-capitalization and large-capitalization (small-cap, large-cap) of the market. Solution for this are index funds. Index funds hold each company in proportion to its market capitalization. I provide an example: S&P 500 is an index fund with 500 large companies chosen by Standard and Poor`s as representatives of the U.S. industry. The biggest company in the S&P 500 is Apple, with a market cap of about $265 trillion, or 7.227% of the index, while Netflix has a market cap of $103.83 billion, or 0.287% of the index - twenty five times smaller than Apple. So if you want to track S&P 500 you would have to own 25 times as much Apple as Netflix. Imagine managing it yourself, when there are much more publicly traded companies in the U.S., so index funds can do it for you - proportionally allocate your investments according to their weight. S&P 500 is only about 70-80% of total market cap, so the other part we can get from S&P 600 or Russell 2000, it`s up to you.
Diversify
Why does diversification matter? “...poorly diversified strategies do indeed maximize your chances of winding up with bags of money. Unfortunately, they also maximize your chances of ending your days in a trailer park.” (The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein p.104).
As you may have noticed, I haven`t said a word about buying individual stocks. That`s because they are not diversified. “But I like Tesla and I want to invest in their company,” you may say. You can invest in whatever you like: Tesla, Google, NVIDIA. Since you invest in S&P 500 you`ve already invested in those companies. If you want to invest in a certain company, you can surely do that. The only thing you should take care of is to make sure, that portion of it is less than 10% of your portfolio to keep it properly diversified.
euro cost averaging
During the year stock prices may be at rock-bottom or at the peak and if you start investing at the peak and put the whole money at once, you most likely lose it or, at best, it will take some time to recover. This is not the scenario we want, right? You'll lose them only if you sell your assets when the price is low. No matter where the market is right now, the number of shares you`ve already had stays the same. To avoid this, you should invest periodically - the same amount once or twice a month. This strategy allows us to kill two birds with one stone: we don't need to time the market (even if we want to, we couldn't) and buy assets for average price.
every coin helps
Sticking to your investment plan is a good thing to do, but why don’t we go further and outperform the plan, when we get an opportunity? Even investing extra 10€ that we saved from not buying a coffee this Monday, or this month we get a tax refund or a work bonus - no matter what it is, any unexpected income that we invest will notably bring us closer to our investment goal.
Step IV: Simplify and Automate
Almost every investing platform has autoinvest feature. It works pretty simple: you choose how often you want them to charge you X amount of money, and that's it. After they charge you, they allocate money between your assets according to its index to keep the proportion the same. Once you set it, you don`t have to spend mental energy on remembering to make monthly payments. Simply set and forget about it. After that the only thing you should do is rebalance your portfolio once or twice a year.
Step V: do your own research.
The last thing I want to tell you about is to do your own research. Double check and question every piece of information you get, especially if we are talking about money, because nobody cares for your money more than you do.
conclusion
To start investing with almost no effort, but wisely you need:
- build an emergency fund
- pick your investing platform
- build diversified portfolio
- minimize effort with autoinvest feature
- double check any information you get