101: Learning to Invest

The biggest decision you need to make right now is whether you want to be an active or passive investor. If done right, both can yield similar long-term results — but which path fits you depends entirely on your character.

Long-term investing requires self-knowledge above all else. Understanding your own personality and habits matters more at this stage than understanding the markets.

Investing in stocks used to be attainable only by those with significant capital and happened through brokerage firms. With the advent of the internet, and the pioneering work of retail brokers like E*TRADE, personal investing changed dramatically. Today anyone over 18 years of age can open an investment account through platforms such as Robinhood, Fidelity, or Charles Schwab, to name a few.

When COVID-19 forced people inside, keeping them from working and social outlets (specifically gambling), many turned to online forums and day trading. There was a huge surge in the number of day traders, and today they make up over a third of the market volume[1] with a total capital of over $13 trillion; roughly 10% of the total stock market. Forums such as Reddit allow traders to band together and drive swings in individual stocks. This is well known from the squeeze put on short-sellers of GameStop, where they lost millions as retail investors drove the stock price higher over the course of a month, to the aftermath of Tesla's stock declining sharply amid controversy over Elon Musk's entry into government and leading the Department of Government Efficiency (DOGE).[2]

Even before COVID-19, investing had been treated like a sport since the early 2000s. Commentary is provided around the clock on why the market moved or what the expectation is for the market to move that day. Especially the time from the pre-market open to the post-market close. "Experts" are providing their opinion on why the market moved one way or another, why a stock, or set of stocks, is over or underpriced, and why you should or shouldn't invest in this assets now! Thanks to the 24 hour news cycle, the internet and television, these outlets provide an opinion and a narrative for every move, every market makes across the globe. As long as one guest says the market will drop 10%, and another says it will gain 10%, the host is never wrong. When the market eventually fluctuates enough to prove one of them correct, the network brags about how you "heard it here first." In reality, they are doing nothing more than gambling with your insecurity. Just like a casino, the house is stacked in their favor.

Take a moment and think of yourself ten years from now. You have been successful in saving, and all your investment accounts have $100,000 across them. You usually don't check your account but you logged in today. Unfortunately, today the market closed down 1% and your balance shows you 'lost' $1,000. How does this make you feel? What would you do? Do you panic? The way you see yourself reacting to this exact scenario indicates the type of investor you are and how you should manage expectations. If you would panic, even just a little, then you need to be hands off as much as possible. Set up your investment strategy and your regular contributions and then forget it. Check once a year that you are still wanting the same strategy and increase your contribution rates, if possible, and then forget about it for another year.

Personally, I check the market nearly every day but I never act on those events. I tried when I was young and I lost big. I had to teach myself all the things I am writing on these pages for you to not have to lose big. In the end, trying to time investments you win some, but you lose a lot more. I have had to completely change my perspective with investing and since I did this things have worked out remarkably. I listen, and watch, and wait for opportunity to open up in stocks I plan to hold for the next twenty plus years — looking for a good price. That good price is a value I have decided I am willing to pay for the stock. If it goes below that value then I don't care because I still feel I got it for the value I wanted. Eventually it should rise again if you wait long enough. My wife is the polar opposite. She cannot even open the account to check our balances. The mere fact that our balance swings by such large values on a daily basis makes her very anxious — even though she knows it's just statistics and she sees how much the total value of our investments has increased over time.

Due to the higher number of retail investors mentioned above, this fluctuation has become even more extreme on a daily basis than it was a decade or more ago. The market goes up and it goes down — but over time, and that is the key point, given a long enough time frame, the market outperforms basic investments in bonds or savings accounts.

All of this is to say that before you start investing, you have to recognize how you will react. Invest in a way that minimizes the risk you will do something drastic when the market falls 20%, because it will. The biggest mistake you can make is to react. By the time you react you are already too late. Most people pull their money out too late and then put it back in too late when the market recovers — causing them to lose out on even more gains. How much a market fluctuation of this magnitude matters depends on how old you are and how close you are to needing this money. Never put money in the market that you will possibly need within a year (for instance emergency savings). If you are 20 years old and reading this to invest soundly for retirement, there is absolutely no reason you ever need to react for at least the next 30 years. That is a long time to let your money sit and compound.

Types of Investments

Once you understand your temperament and time horizon, the next step is knowing what you can actually buy and the types of accounts that exist for investing. The investment world has its own vocabulary, but the core categories are straightforward.

Stocks are shares of ownership in a company — when the company grows in value, so does your stake. When they make profits they typically distribute those profits as shareholder dividends. Bonds are loans companies and governments make in exchange for regular interest payments; they are generally more stable than stocks but grow more slowly over the long term. Bonds are rated based on the strength of the entity issuing the bond and is reflected in the bond's interest rate and default rate.Mutual funds and ETFs (Exchange-Traded Funds) are baskets of stocks, bonds, or both, letting you spread your money across many companies at once rather than betting on a single one. They cover every type of grouping of companies you can think of and each one must identify what the core investment strategy is for their shareholders. An index fund is a mutual fund or ETF that simply tracks a market index — such as the S&P 500 or the Russel 2000— rather than relying on a fund manager to pick individual stocks. They still have a fund manager but this is passive management as they must stick to a ratio of the stocks in the index. Index funds typically carry lower costs and, over the long run, tend to outperform most actively managed alternatives. The fund picking and active manager of an ETF or Mutual fund does directly relates to the cost of holding this fund. The expectation is you will do better than an index by allowing these managers to pick the stocks for the fund. In practice, it is a very rare case for an active fund to beat a passive index fund.

For most people starting out, a low-cost index fund, held inside a retirement account, is the most practical and proven place to begin. The next lesson walks through the specific rules, funds, and account types that put these ideas into action for retirement accounts.

Final Thought

Investing is not about finding the right stock at the right moment. It is about knowing yourself well enough to stay the course when the market tests your resolve — and it will. The investor who understands their own temperament and sticks to a consistent plan will almost always outperform the one who reacts to external factors.

When you are ready to move from mindset to mechanics, continue to Investing for Retirement, or build your foundation first by visiting Learning to Budget.