Learning the stock market seems difficult.
But contrary to popular belief, the best amateur investors are not the investors who know the most.
Instead, the simplest of strategies has proven to be the most effective way to build wealth.
When learning the stock market, here are eight simple rules to follow.
#1. Focus On Your Savings Rate
Who will have accumulated more wealth in 10 years: someone with $500 to invest who is willing to take a risk to find the next Facebook, or someone who chooses a simple investing strategy but is focused on growing the percent of their income they save?
I’ll put my money on the second one every time.
Many beginners fail to start investing because they think they don’t have enough money.
But a better approach would be to start with whatever you can. Then, to focus on increasing your savings rate over time.
Even if you’re investing 1% of your income, that’s better than 0%. The important thing to do is get started, with the idea you’re going to progressively increase the amount you save.
#2. Choose Your Asset Allocation Wisely
If you’re committed to investing, the next question is this: what should you invest in?
This question is hotly debated. With so many opinions out there, it’s best to go with facts.
Here’s the truth when it comes to investing… passive investor returns are superior to active investor returns.
From the most recent DALBAR study, which tracks returns of passive investors vs. active investors over a 30-year period:
- 10.35% — 30-year return of S&P 500
- 3.66% — 30-year average return of equity investors
To simplify: Investors who tried to beat the market averaged a return of 3.66%. All that time, the 30-year return of the S&P 500 index was 10.35%. So, instead of worrying about finding the perfect mutual fund or stock, you’re much better off investing in the entire stock market.
What’s nice is that the strategy that involves less time, less effort and less worry turns out to be the superior strategy.
Here’s two good options for getting started:
- Vanguard — this is where I invest my own money using their Target Date Retirement Fund. Their minimums are $1,000.
- Betterment — this is my recommendation for those who prefer a totally hands-off approach. Their minimums start at $1.
Related reading: Betterment vs. Vanguard.
#3. Minimize Fees
Why do so many investors, including professionals, underperform the market?
One reason is fees.
A large percentage of the 6.69% gap between between index funds and active investors is fees.
Fees for transactions, management fees, fees to attract new investors, etc…
Investment companies make money with fees. These fees subtract from the money you make.
Fortunately, fees are something you can control.
Betterment, as I mentioned above, has a .25% fee.
Vanguard’s Target Date Retirement Fund has a .16% fee.
#4. Minimize Taxes
What else can you control?
Every dollar you don’t pay in taxes goes towards increasing your overall return.
The smart strategy here is to invest in retirement accounts like IRAs and 401(k)s.
More advanced strategies include things like tax loss harvesting and allocating your assets properly within your retirement and taxable accounts.
This is something Betterment can take care of for you (at no additional fee).
#5. Automate Contributions
You don’t want to think too much about investing.
Automate as much of your savings as you can. For some, this means investing into a 401(k). For others, it may mean setting up automatic withdrawals from your bank account to an IRA or taxable account.
#6. Set Alerts to Increase Your Saving Rate
Your savings rate determines the speed at which you accumulate wealth. The larger the gap between your income and expenses, the better.
Most of us decide one day to save say 10% or so in our 401(k), then we leave it at that. Years go by without thinking about increasing that amount, even after multiple increases in income.
Instead, get in the habit of increasing your savings rate on a recurring basis.
Try to increase the amount of your income that you save by 1% per quarter. That’s very doable. And if you achieve that goal, it will take you just over six years to reach a 25% savings rate.
Something I do to help is set a calendar alert to remind me to increase my savings rate by 1% every 90 days.
#7. There’s No Escaping Risk
Two months back on The Ways To Wealth’s Facebook Page, I posted:
The chart below, from the post, is concerning:
Based on that data, younger investors are much more conservative than older investors.
But here’s the thing — there’s no escaping risk.
Keeping your money in cash means losing money to inflation every year.
Yes, the stock market is risky. However, the longer you stay invested, the less risky it gets.
Below is a chart that shows the range of returns the stock market has provided over different 30-year periods.
Source: A Wealth of Common Sense.
So a hair below 8% was the worst the stock market performed. Even if you had the unfortunate timing of investing over the worst possible 30-year span since 1926, you still returned almost 8% (or around 5% after inflation).
Yes, there are years when the stock market declines. But as long as you don’t sell when it’s down and maintain a long-term perspective, there’s little risk.
#8. Set Realistic Expectations
Investing is a great way to build incredible wealth. In fact, it’s an absolute requirement if your ultimate goal is to someday become rich.
However, many go in with the mindset that they’re going to double their money again and again and get rich quickly.
But that’s not how successful investors think and act.
Instead, successful investors more or less wake up millionaires.
In other words, over 10+ years they save a good chunk of their income. They stay invested during good times and bad. And then, one day, they look up to see their accounts have surpassed $1 million.
This was pretty much all going on in the background while they set up systems to invest their money.
The S&P 500 Index has returned about 10% for the last 30 years. After inflation, that’s about 7%.
While over one year that means $1,000 on average will turn into $1,070, over 30 years that $1,000 will turn into $7,612.
Of course, you don’t want to stop at $1,000.
If you were to invest $1,000 a month (a 25% savings rate on a $4,000 a month income) for 30 years, you’d have $1,220,488.
The important thing is to get started. Again, here are two solid investment providers you can start with today:
- Vanguard — where I invest the bulk of my money.
- Betterment — a good option for those who want a hands off approach, and don’t have the $1,000 required to open a Vanguard account.
Further reading: The best stock market and investing books for beginners.