A friend asked for some investing advice a few years ago. Here was my response.
I have a feeling this is going to be long… :-)
First thing - I don’t know your exact financial situation, but I know you’re in great shape for the long run. Anyone thinking this seriously about their finances this early in life will do fine. Also, since I don’t know much about your exact situation, this may be a little ‘condescending’. I’m sure you know I don’t mean it that way. Just take what you need from it and leave the rest. Also feel free to ask questions about anything at any time. I love finances and it would be my pleasure to help if there’s any way that I can. I’ve read A LOT of books and stuff, so it would be nice to be of use to others.
The ABSOLUTE most important thing is to get out of debt. Nothing kills your financial future more than debt. No matter how good of an investor you are, you won’t get anywhere if you don’t take control of debt. Make that your main focus. Until you are completely debt-free (except for a mortgage), I wouldn’t put too much time into investing. Have you heard of Dave Ramsey? He has an excellent talk-radio show about getting out of debt. It’s a bit basic sometimes, and like all talk-radio hosts, he’s “over-the-top”, but he provides really useful information. The most valuable thing about it is the repetition. Listeners call in with their financial situation and he takes each one of them through the same process. He calls them the Baby Steps, and they’re really just common sense, but listening to him walk listeners through them over and over makes it stick in your head. He also advocates developing a laser-like focus. Don’t try to do a hundred things at once. Focus on one thing at a time, whether it’s paying off one credit card, or building up an emergency fund, or whatever. Once that one thing is done, then move to the next item. That simplifies life and is a better use of your energy than trying to fix everything with little bits of your attention here and little bits over there.
A book that everyone should read is The Millionaire Next Door, which discusses the habits that financially successful people share. It also focuses on getting out of debt and living more simply. The advice seems pretty sound even though the methodology of the book isn’t. Taking a bunch of millionaires and finding out common features among them is not good science.
All that said, thinking about investing at any time is a useful endeavor. Just as long as you maintain your focus on getting out of debt.
The only people who should be investing in individual stocks are those who enjoy it. If you don’t relish reading financial statements and analyzing stock valuations, then you shouldn’t be doing it. Life is too short. Do stuff you enjoy and make your financial plan as simple as possible. Your overall return will still be in the top 10-20% of all investors.
The most important part of investing is following a strict plan. And that plan should be focused on asset allocation. What does that mean? There are various classes of assets that you can invest in. The most common ones are stocks, bonds, and real estate. Within each class, there are subclasses, like small stocks, value stocks, international stocks, etc. It’s almost impossible to know which class will do well over the short term, even though the talking heads on CNBC will tell you they think they know. Studies show that it’s a toss up. So, the smartest thing to do is to look at the long term return of each asset class (past 20-50 years), decide what percent of your portfolio you want to place in each class, and then STICK WITH IT THROUGH THICK AND THIN. That is capitalized because that is the most important part. If you constantly adjust your percentages because you “think” large tech stocks are going to start doing well, then you will kill this approach. Everyone thought tech stocks were going to do well in 1999. 2000 killed them. My favorite book describing this strategy and the rationale behind it is A Random Walk Down Wall Street by Burton Malkiel.
Once you decide what your asset classes should be and what percentages you want to invest in each (I can help you with suggestions), then you find a LOW COST index fund (or ETF) that tracks that asset class and buy the appropriate amount. Then just leave it alone until next year. Look at the results and if one or more asset classes has gotten out of whack with your desired percentages, then rebalance. Sell a little of the one which has gotten too big and buy a little of the one that has gotten too small.
This way, you are automatically selling an asset class AFTER it has risen and buying an asset class when it has been beaten down. You’re buying low and selling high.
For someone who wanted the simplest possible investment plan, I would recommend putting 75% of their portfolio into a broad stock fund (VFINX or VTSMX) and 25% into a simple low-cost bond fund (VBMFX). Then just rebalance every year. But you can also make this more complex by splitting the stock portion into domestic and international, then small and large companies, etc. It can be as complex as you want; just be sure to keep it consistent from year to year. That is the key which will allow you to buy assets when they are at their low point and sell them when they are high.
Now, if you want to invest in individual stocks, I’d recommend keeping it to a small portion of your overall portfolio (< 10%). Figuring out how to value stocks is an art that takes a lifetime. The one book that I’d recommend is The Intelligent Investor, by Benjamin Graham. It was written decades ago, but it gives the groundwork necessary to understand how to invest in stocks.
In order to really successfully invest in individual stocks, you need to be able to identify companies that have a sustainable competitive advantage. This is something that I have a lot of trouble with and haven’t really pursued enough. This is what Warren Buffett does. If you really want to understand this process, read everything on this page.
This email is getting a bit long. So let me know if what I scribbled is understandable and if you have any questions. There’s more trivia locked up in this brain of mine, if you want more :-)
Must read books: - Millionaire next door - A Random Walk Down Wallstreet - Intelligent Investor
Good intro web site: - Motley Fool
Radio show (can download podcasts to listen whenever you want): - Dave Ramsey show