3 Biggest Myths about Investing
Starting to invest is not easy and to many it is a daunting task to start. I remember when I started investing. I was always worried about making the wrong investment or losing all my money. I had all these ideas in my mind that prevented me from actually pulling the trigger and starting. For example, I thought that I needed at lot of money to get started or that I didn’t know enough. However, these thoughts are completely wrong, as you will see in the remainder of this post.
I will go over the three oldest myths and provide a detailed explanation why they are incorrect and why you should start investing today. Afterward, I will quickly address some questions I am most frequently asked about investing.
Myth 1: You need a lot of money to start investing
One of the longest and oldest myths is that you need a lot of money to start investing. This, however, is completely false. You can technically start investing with as little as $1.00 using apps such as Acorns or Robinhood that use a fairly new concept called fractional trading, where you purchase a percentage of a stock. That being said, it does not allow for much diversification, which is why I suggest having a minimum of $100.
I would actually argue that it is better to start investing with little money as you are bound to make mistakes. These mistakes are not a bad thing because they will teach you about the market, what to look out for, and why certain stocks act the way they do. More importantly however, these mistakes will teach you how to handle the emotions that come with investing when you experience your first loss. It is better to lose 5% of a $100 than 5% of $100,000 when you first start trading. It is during this period where you can differentiate yourself from the other investors. Always ask yourself:
Why did the market go down or up?
Why was I wrong?
If I was right, was my initial reasoning the correct reasoning? Or was it something else that made the move?
What are the 3 most important take-aways from this experience?
I think it is always a good habit to ask what the 3 most important take-aways are. I personally follow this rule every time I read an article, paper, newspaper, financial report, etc.
After you've made your first few mistakes with $100, then you can move up and hopefully make less mistakes. There is a reason that Robert Kiyosaki advices to not be afraid of losses and to welcome those mistakes, because experience makes you smarter.
Myth 2: You need to be smart
Warren Buffet, arguably the most successful investor ever, has said numerous times that anyone with an average IQ can do what he does, you do not need to be super intelligent, you just need to be diligent. He has a well-defined system that works for him and that takes the emotion out of it. I believe that this is the key piece of wisdom "taking the emotion out of it" which comes with experience, and why it is smart to start with a small amount or a paper trading account (although paper trading does not evoke the same emotions as loosing real money).
Mr. Buffett and Benjamin Graham have introduced a fictional character, called Mr. Market. Mr. Market is a very emotional investor (some might say speculator) and follows the market trends. He buys when the stock has gone up a lot trying to ride the wave even further. But, when the downturn comes his investments are turning into losses, which makes him panic and sell his stocks at a loss. In essence he has bought high and sold low, the exact opposite of what the intelligent investor should do. Mr. Market represents 99% of the investors currently in the markets and it are exactly those type of investors that Warren Buffett likes to trade with, meaning he buys low and sells high, making a tremendous profit.
Investment behavior of Mr. Market
However, one of the few critical skills that you do need to acquire is accounting. I am not talking about T-accounts and ledgers, but financial accounting. The better you understand accounting, the easier it will be. You will spot inconsistencies and notice when managers are using a lot of "tricks" to make the books look good. By repeatedly exposing yourself to financial statement, reading the footnotes, and even some textbooks on accounting you will increase your understanding exponentially. This is one of the few skills that has a tremendous return on investment (ROI). An understanding of accounting can also tell you a little bit more about the top management teams or upper echelons and their personal values.
One of Warren Buffett's tenants is "stay within your circle of competence" meaning invest in industries that you know well and do not try to understand everything. In essence, this means find your niche and stick to it. Many investors mocked Buffett for not investing in tech stocks in 2000, but he always claimed that he does not understand the industry and will not invest in it. This turned out to be smart, since apparently nobody understood the industry and the tech-bubble burst.
You could rephrase this to: “Find your niche and stick to it.” Finding your niche might seem difficult in the beginning but everyone can do it, everyone has something they are good or interested in. This can be:
A favorite class in school - marketing
Something you know a lot about or a general interest - computers
A hobby - gaming
Once you've figured out your niche you delve completely into it and learn as much as possible. You'll be surprised how much you actually know. Many analysts cover a variety of companies and are not able to go into as much depth as you, or they are not in touch with reality. For example, an analyst covering the gaming industry might know about the trends, but if they do not actually play the game or go on the forums, they might not know what the community is thinking.
Finally, a good strategy to always do well and that doesn't require supernatural intelligence is by actually following the market. This can be done by buying an ETF that mimics the market, a good example is the Spyder ETF - SPY.
Myth 3: It is impossible to beat the market
This myth is a half-myth and one that a lot of people have a lot of different opinions about. I do have to agree, that I believe that the average investor or even the average "professional" analyst or fund manager is not able to beat the market, and the statistics support this.
We can see that even in 1 year, more than 50% of the large cap funds underperform the market (represented by the S&P 500). After 15 years, more than 90% underperform.
The graphs below show that the results are very similar for fund managers. And even more impressive is the growth between 2009 and 2014 in underperformance by domestic equity funds. They do not just underperform the S&P 500 but also the larger S&P 1500 composite.
Percentage of domestic equity funds underperforming the S&P 1,500 composite
However, even though the evidence above is strong, I would like to mention the analogy of the gorilla stated by Warren Buffett. The analogy is simple, let’s say you have a dice-game where you win a $100 every time a gorilla rolls a 6. Now statistically the gorilla has a 1/6 chance of rolling a 6, which is something that is achievable by a large percentage of gorillas, it’s just luck after all. However, the chances of rolling 10 consecutive sixes in a row are = or 0.000001654%. Realistically it could be possible that in the entire world there are 4 gorillas that are lucky enough to be able to do this. Which could then be attributed to good luck or fortune. However, if you find out that all these gorillas come from the same enclosure in the same zoo, then you might start to think that there is more to it than luck. This is analogous to Warren Buffett’s investment strategy and style. He has consistently beat the market and had excellent returns and so have those who were under his tutelage and use the same value investing strategy.
Therefore, it is possible to beat the market, but it is very hard to do this consistently. That is why you need a good set of core values and strategies.
Frequently Asked Questions
How do I start Investing with little money?
There are plenty of apps and platforms that allow you to invest with minimal money. The important thing when you start investing is not to make millions of dollars, but to gain experience and develop a strategy. This is best done with smaller amounts where you can learn as you go, and you do not incur huge losses. Some of the following apps allow you to invest with little money:
Robinhood
Acorns (you can use this for free if you have a .edu college account)
Stash (this one is in my opinion the best one when you are still learning)
Vault
What is ESG investing?
ESG or Environmental, Social, and Governance are the three accepted branches of sustainability and focus on the impact a firm has on its environment, society, and its stakeholders. Usually ESG investors set certain rules for their investment strategy, such as:
Don’t invest in companies that are harmful to society (tobacco, coal, alcohol, guns, …)
Focus on companies that promote sustainability (reducing carbon footprint, donate to a good cause, …)
Or those with specific governance traits (% of women on the board, % of minorities employed, …)
What are the basics of investing?
Different strategies have different basics, for example technical vs fundamental or momentum vs contrarian trading. The actual basics of the strategy you chose to follow are not as important in the beginning as the habits you create early on in your career.
I would argue that the most important thing for a starting investor is to cultivate good habits. I will go into much more detail in a later post, but below I will list some of the most important habits and traits an investor can have:
Read, read, read – Warren Buffett is said to read about 500 pages a day. Most of his time in the office is spent reading books or financial statements, not checking his portfolio.
Learn, learn, learn – It is not just reading but you have to actively learn, take notes on what you read, see how the things you read are connected or how they can complement each other. Also, if you already know your niche, try to become a specialist by reading trade magazine, forums, journal articles, blog posts, etc.
Dedicate a set time slot to your investing activities and make it sacred. No one should be allowed to interfere with this time.
Take notes prior to, and after investing. Before you make the decision, you should have taken diligent notes as to why you decided to invest in that particular company compared to some of the other options. A few days or weeks after the investment you should follow up with your investment and try to pinpoint why a certain stock behaved the way it did. Were you right or wrong? Why were you right or wrong?
The market is always right, even when it is wrong. The market can be wrong much longer than you can stay liquid.
If you follow these steps, then over time you will develop your own rules for trading such as cut your losses at x% or reevaluate your position at x% of profit.
What stocks to buy as a beginner?
If you read the post above, you will notice that as a beginner it isn’t that important which stock you buy. The important thing in the beginning is to gain experience and learn from the process. Don’t be fooled by anyone who claims to be 100% sure about what stocks to buy or what stock is the best stock for beginners, these are liars and are trying to profit from novice investors. However, this won’t happen to you after reading this blog. Investors don’t need to be right 100% of the time, their profits just need to outweigh their losses.
If you have any other questions, feel free to ask them and I’ll do my best to answer them to the best of my knowledge.