After seeing the news come in Thursday night last week and the resulting stock market crash on Friday, I found myself discussing Brexit and other macroeconomic factors during the weekend. This all inspired me to write my 2nd article on investing, where I’ll focus on elements of investing we can control & what we can do about large market events such as Brexit.
My first article on investing was everything any new investor would need to officially become an investor. The first lessons on investing were simple: remove productive procrastination, avoid analysis paralysis, and finally, buy low cost index funds at any point we have cash available to invest. A part of the advice was also discussing how timing the market is not as important as time in the market, as Warren Buffett would put it.
Investing 201: Two Elements We Can Control
When it comes to investing, there are two items we can control.
The 1st item is at the heart of what many personal bloggers (myself included) will rail against, and that is high fees.
When we purchase a mutual fund from an advisor, he might charge us X% based on his, “service fee,” in addition to the mutual fund charging us up to 2% (sometimes more) to hold our money. When it comes to fees, they can eat away at our portfolio at a staggering rate.
The diagram below demonstrates fees in the 0.25% to 1% range.
Fees from the example I outlined above that range in the 2%+ range will further eat into the final investment amount by more than 50%.
The 2nd item might be more familiarly described as being frugal.
If we create a large gap between income and expenses, then we are left with a large amount of cash each month that will be put to work making more money for us. I love the feeling each month knowing that our portfolio is growing because we found easy 1% improvements to strengthen our financial lives.
This is what I mean when I tell people I am seeking to move away from being an employee as I transition to becoming an investor. It is another way of describing the pursuit of financial independence.
Of course, if you are in a position where money is tight, frugality might not offer you any comfort as every dollar is already being put to good use. This article will only help once you find yourself in a position with expendable income.
Investing 201: Beating Brexit & Other Common Investment Mistakes
My view on Brexit can be summarized by borrowing a quote from Charlie Munger, “Microeconomics is what we do, and macroeconomics is what we put up with.”
Now that the micro elements were covered above, I can speak more to the larger macroeconomic events that will alter our net worth. Brexit was seen as highly improbable, even days before the event. This is not to say it was impossible, as is clearly evidenced by the results.
As I found myself watching a 3.65% market decline on Friday, I quickly tweeted out:
While I do believe it was an excellent time to buy, I wanted to reiterate that ANY time we have cash available to invest, it is a great time to buy.
For me, I don’t necessarily have cash to invest, but I decided to put a few hundred dollars extra while committing to a slightly larger level of frugality over the next few weeks to make up the difference.
So while Friday evening may have seen stocks on “sale,” it is worth remembering, for practically all of January, February, most of March and even parts of May, the market was trading at levels BELOW the close on Friday.
If you’re like me and know people who allocated their portfolio into cash ahead of the Brexit decision only to then buy on Friday’s dip, then we can contribute their success to dumb luck over market awareness.
This creates a common mistake many investors face: becoming overconfident.
For the smaller investors, we can have a long streak of right calls over our lives, but it only takes a few large mistakes to demolish a portfolio.
The first line in my new “Start Here” page summarizes it all, “We don’t need to have a high IQ to become financially independent, we only need to avoid real stupid mistakes.”
Investing our money by making a prediction on Brexit is moving away from investing and into the realm of trading. We can make money there, but this new realm is more akin to gambling than anything else.
Trading on speculation is a different path to wealth altogether.
If we find success early in our career then it might be decades before the results are “averaged” out. It is often better to lose money in the market while we are young so that we can avoid such a fate when dealing with larger amounts closer to retirement.
Overconfidence early in our lives may lead to us to discover too late, that we placed all our eggs in the wrong basket.
Every investor needs to be aware of the effects overconfidence can have on their net worth.
On a personal level, I purchased Tesla shares at $119 and felt like a genius when they skyrocketed to $279 in a little over a year. A foolish version of myself may have bought much more while prices were high only to see them come crashing down again to the current price of $193.
This position is held in what I consider a “play fund,” that will never go beyond 5% of my overall asset allocation.
If you’re still itching to make those market predictions, then I will recommend you follow this approach and set yourself up with something small around 5% before making a larger commitment.
I have found myself wanting to try and time events such as Brexit or to buy more individual shares in various companies. When tempted, I remind myself that the tried and true method is to invest a piece of every paycheck into low-cost index funds from Vanguard while avoiding any decisions related to large macroeconomic events.
Have you been burned by a large financial mistake early in your career? Are you happy with index fund investing like we are? Do you prefer to trade ahead of macroeconomic events, such as Brexit?
*Source for the featured image: http://cdn.spectator.co.uk/content/uploads/2016/01/iStock_000068483899_Large.jpg