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Know the basics to avoid wasting time and money in the stock market.

By: Clément Bourcart

Source:https://themakingofamillionaire.com/

Photo by MayoFi on Unsplash

I’m sick of the talking heads and self-proclaimed experts scaring the masses away from investing.

People who use complex language and make investing sound like a thing reserved for the elite and the pros have an interest in maintaining the status quo.

They benefit from spreading this image in the minds of whoever will listen.

The story goes something like this.

“You can’t make your wealth grow on your own. You need a trusted advisor to manage your money for you and tell you what to do. Hire me, and it’ll only cost you an arm and a leg. No catch!”…

The good news? There’s another way. A simple, easy-to-understand, replicable process to charting your own path to wealth.

How can you do that? Below are 3 dead simple ways, which the founder of index funds, John Bodle, revealed in an interview with Tony Robbins.

I’ve personally applied these insights to go from £0 to £100k in just 5 years by investing regularly in funds. In as little as 10 minutes every month.

These kinds of results are available to anyone who is willing to stick to a simple, proven formula for long-term success without getting distracted by the new shiny things and false promises of “get-rich-quick” schemes.

#1. Allocate your assets based on your appetite for risk and financial goals

When building your investment portfolio, you can choose to put your money into 5 different asset classes:

• Shares in companies listed in the stock market.
• Bonds issued by institutions and governments.
• Commodities, such as oil and gold.
• Real estate, either directly investing in property or buying shares in investment trusts.
• Cash for any short-term purchases or as a safety pot for rainy days.

Now, each of those asset classes has its own degree of risk and return potential.

Though there are no hard and fast rules, typically, stocks and shares tend to generate high returns at the expense of higher risk levels.

The higher the returns of your assets, the higher the risks involved.

Those funds and shares that perform well will also be more volatile. This means the value of your investments could go up and down quite frequently, and when you don’t expect it.

Therefore, if your goal is to finance a car purchase in 3 months’ time, such volatile assets as the riskier stocks may not be the best match right now.

Conversely, if you’re just out of college and you’re looking to invest over a lifetime, you can take on more risk and accept the volatility that comes with it.

The highs and lows of the stock market are more likely to even out over decades if you stay in the market during that time.

If you’re at the stage of life where you’re nearing retirement, then you might want to scale back on aggressive stocks or funds in favor of more stable assets. These could be government-backed bonds or commodities like gold.

The point is to be clear about what you’re willing to risk and what you’re aiming for with your investment portfolio.

To help with this, ask yourself:

• What are your cash needs now versus a year from now? 5 years from now? Is there a big expense on the horizon, such as planning for your kids’ education, that you’ll need to fund?
• What is your long-term goal with investing? Are you willing to stay in over the long-term to generate true, lasting wealth?

If the answer to the above is yes, the next step is to…

#2. Diversify your assets and avoid hefty fees

Diversification and keeping costs low are essential factors when building a profitable portfolio.

Let’s break this down in simple terms.

2.1 Diversifying your assets

All this means is not putting all your eggs in one basket.

If a hungry fox comes sniffing around your basket and eats all the eggs inside, you’re screwed.

If you have multiple baskets in different places, though, the impact of losing one won’t be quite as bad.

Simply put, there are 3 main ways you can diversify your investments.

• Asset diversification: you can spread your bets across multiple assets, such as owning 60% in stocks, 10% in bonds, and the remaining 30% in commodities.
• Sectoral diversification: you can choose funds that are focused on certain sectors (such as Consumer Goods, Healthcare, or Industrials). By combining such funds, your investments are split out across all those sectors. If one is performing poorly, the odds are the others will compensate.
• Geographic diversification: funds let you invest your money in a range of companies operating across the globe. This mitigates risk as if one area is subject to political turmoil or civil unrest; others are likely not.

2.2 Avoiding hefty fees

You want to avoid funds that incur large fees over time. Why is that? Because, just like your earnings compound and grow over time, so do your costs.

When searching for funds, take time to examine their datasheets and associated costs. It may not seem like a big deal, but the difference between a total expense ratio of 1% versus 2% will be huge over the decades in the market.

As John Bogle says:

“Compounded over that time frame [60 years], the high costs of investing can confiscate an astounding 70% of your lifetime returns!”

Paying high fees for funds that are actively managed only eats at your returns. There’s no guarantee those funds will outperform index trackers that simply replicate the returns of an existing index, like the S&P 500, at a much lower cost.

Active managers spend their days trying to “beat the market” by timing when to enter and exit trades. In the process, they’re charging you, the investor, fees for their expertise.

What’s more, the funds rack up transaction fees for all this trading activity inside the fund (buying and selling shares of the companies that make up the fund).

That’s not a good deal for you as an investor unless you know for sure that these active funds are going to produce superior returns. Something that no one fund manager or expert can honestly promise.

So, what type of fees should you look out for?

Ongoing charge (service fee) + Transaction costs = Total Expense Ratio

Let’s look closer:

• Ongoing charge: a yearly or quarterly fee you pay the fund manager to cover the ongoing costs of running the fund.
• Transaction costs: the fees you pay each time the fund manager buys and sells shares within the fund (this is why active funds are so expensive since their managers are paid to do this all day long).

That’s all you need to know.

The total expense ratio as a percentage will tell you how much of the money you invest in the fund will be spent on covering fees.

You can then weigh this with potential returns to make an informed choice as to whether paying such costs is justified or not.

3. Don’t tinker with your investments

In other words, be an investor, not a trader.

There’s a big difference between those two.

An investor takes a long-term perspective. They’re not constantly tracking their funds’ performance, and they don’t switch in and out of funds to try and gain short-term profits.

Instead, they buy and hold. For a long time.

As the investing legend Warren Buffet declared, when describing the investment strategies that led him to a net worth of over $80bn:

“Our favorite stock holding period is forever.”

On the other hand, a trader is someone who speculates that the price of this or that asset is going to rise or fall. And places bets accordingly. This is just another form of gambling and involves taking on large amounts of risk.

Not only this, but trading is time-consuming (unless you’re flipping coins to make trading decisions, which would probably get you the same results).

Checking stats as stocks go up and down to try and place trades during the day would take hours and hours. You’d have to stay on top of the economic news, trends, and forecasts. And resort to complex financial analysis techniques and tools to assess every single stock.

Finally, as opposed to investing, trading incurs larger fees. Every time you buy or sell a stock or a fund, you’ll pay transaction fees. Those will accumulate over time, and once again, eat away at your wealth.

The bottom line is this.

If you’re not keen on losing money, taking on huge amounts of risk for no guarantees of success, and waste time trading, stick to long-term investing.

Conclusion

One thing that makes living in our time so fascinating is the ability to access knowledge from the world’s best in any field with a few clicks.

In the world of investing, John Bogle is revered as the father of index funds, making wealth accessible to a larger part of the world’s population at the lowest cost.

The approach to building lasting wealth as a private investor is simple:

• Align your risk appetite and financial goals with the assets you choose to invest in.
• Spread your bets across various assets and funds, and do so at a low cost by favoring passive funds over actively managed ones.
• Stay in the game by holding your investments over long periods of time.

Apply the above, and you’ll stand on solid foundations to build your financial future on.

It’s up to you now. Up to you to own your financial destiny, to make the right choices, and to take action. Starting now.

This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.