General Investing Articles

Cheat Sheet / Updated 10-17-2024

Stocks, bonds, mutual funds, exchange-traded funds, and real estate — the allure of earning high returns from these investments gets people’s attention. However, folks also hear about the risks involved in chasing those greater potential returns when investing. Before you set out to invest, you must get your financial house in order and increase your knowledge to make your best investing decisions. The following list summarizes 20 key themes and actions that can help make you a successful investor.

Cheat Sheet / Updated 03-14-2024

Artificial intelligence (otherwise known as AI) can save you lots of money and help you do things that were either costly or a pipe dream only a few years ago — and that includes helping you with investing and financial pursuits.

Article / Updated 07-07-2023

Plenty of younger folks have debts to pay and lack an emergency reserve of money for unexpected expenses. High-cost debts, such as on a credit card, can be a major impediment to investing, in particular, and accomplishing your future personal and financial goals, in a broader sense. A high interest rate keeps the debt growing and can cause your debt to spiral out of control, which is why dealing with such consumer debt should be your first priority, just before establishing an emergency reserve. Pay off high-cost consumer debt Paying down debts isn’t nearly as exciting as investing, but it can make your investment decisions less difficult. Rather than spending your time investigating specific investments, paying off your debts with money you’ve saved may indeed be your best investment. Consumer debt includes borrowing on credit cards, auto loans, and the like, which are often costly ways to borrow. Banks and other lenders charge higher interest rates for consumer debt than for debt for investments, such as real estate and business, because consumer loans are the riskiest type of loans for a lender. Risk means the chance of the borrower’s defaulting and being unable to pay back all that he or she borrowed. Many folks have credit card debt that costs 18 percent or more per year in interest. Some credit cards levy interest rates well above 20 percent if you make a late payment or two. Reducing and eventually eliminating this debt with your savings is like putting your money in an investment with a guaranteed tax-free return equal to the rate that you pay on your debt. For example, if you have outstanding credit card debt at 18 percent interest, paying off that debt is the same as putting your money to work in an investment with a guaranteed 18 percent tax-free annual return. Because the interest on consumer debt isn’t tax-deductible, you would need to earn more than 18 percent by investing your money elsewhere to net 18 percent after paying taxes. Earning such high investing returns is highly unlikely, and to earn those returns, you’d be forced to take great risk. Consumer debt is hazardous to your long-term financial health (not to mention damaging to your credit score and future ability to borrow for a home or otherwise investments) because it encourages you to borrow against your future earnings. Tapping credit card debt may make sense if you’re financing a business. If you don’t have home equity, personal loans (through a credit card or auto loan) may actually be your lowest-cost source of small-business financing. Establish an emergency reserve You never know what life will bring, so having an accessible reserve of cash to meet unexpected expenses makes good financial sense. If you have generous parents or dear relatives, you can certainly consider using them as your emergency reserve. Just be sure you ask them in advance how they feel about that before you count on receiving funding from them. If you don’t have a financially flush family member, the onus is on you to establish a reserve. You should have at least three months’ worth of living expenses to as much as six months’ worth of living expenses as an emergency reserve. Invest this personal-safety-net money in a money market fund. You may also be able to borrow against your employer-based retirement account or against your home equity, should you find yourself in a bind, but these options are much less desirable. If you don’t have a financial safety net, you may be forced, under duress, to sell an investment (at a relatively low price) that you’ve worked hard for. And selling some investments, such as real estate, can take time and cost significant money (transaction costs, taxes, and so on). Riskier investments like stocks aren’t a suitable place to keep your emergency money invested. While stocks historically have returned about 9 percent per year, about one-third of the time, stocks decline in value in a given year, sometimes substantially. Stocks can drop and have dropped 20, 30, or 50 percent or more over relatively short periods of time. Suppose that such a decline coincides with an emergency, such as the loss of your job or a health problem that creates major medical bills. Your situation may force you to sell at a loss, perhaps a substantial one. Stocks are intended to be a longer-term investment, not an investment that you expect (or need) to sell in the near future.

Article / Updated 06-06-2023

Investing might not seem controversial, but it shouldn’t surprise you that anytime you’re talking about money, people have some strong opinions about the right way to do things. The first way investors categorize themselves is by whether they are passive or active. Because these two approaches are so different, the following information helps you think about what they are and which camp you see yourself in. How to know if you’re a passive investor Passive investors don’t try to beat the stock market. They merely try to keep up with it by owning all the stocks in an index. An index is a basket of stocks that mirrors the market. Passive investors are happy matching the market’s performance. You know you’re a passive investor if you like the following ideas: Not picking individual stocks: These investors buy large baskets of stocks that mirror the performance of popular stock indexes like the Dow Jones Industrial Average or the Standard & Poor’s 500 index so they don’t worry about whether a small upstart company they invested in will release its new product on time and whether it will be well received. Owning mutual and exchange-traded funds: Because passive investors aren’t looking for the next Microsoft, Google, or Apple, they buy mutual and exchange-traded funds that buy hundreds of stocks. (We cover mutual and exchange-traded funds in more detail in Book 5.) Reducing taxes: Passive investors tend to buy investments and forget about them until many years later when they need the money. This can be lucrative because by holding onto diversified investments for a long time and not selling them, passive investors can postpone when they have to pay capital gains taxes. Not stressing about stocks’ daily, monthly, or even annual movements: Passive investors tend to buy index or mutual funds and forget about them. They don’t need to sit in front of financial TV shows, surf countless financial websites, read magazines, or worry about where stocks are moving. They’re invested for the long term, and everything else is just noise to them. Sites for passive investors to start with One of the toughest things about being a passive investor is sitting still during a bull market when everyone else seems to be making more than you. Yes, you might be able to turn off the TV, but inevitably you’ll bump into someone who brags about his or her giant gains and laughs at you for being satisfied with 10 percent market returns. When that happens, it’s even more important to stick with your philosophy. Following the crowd at this moment undermines the value of your strategy. That’s why even passive investors are well served going to websites where other passive investors congregate: Bogleheads is an electronic water cooler for fans of Vanguard index funds and passive investors to meet, encourage, and advise each other. They call themselves Bogleheads in honor of the founder of Vanguard, John Bogle. The Arithmetic of Active Management is a reprint of an article by an early proponent of passive investing, William Sharpe, who explains why active investing can never win. Vanguard’s website contains many helpful stories about the power of index investing and offers them for free, even if you don’t have an account. How to know whether you’re an active investor Active investors almost feel sorry for passive investors. Why would anyone be satisfied just matching the stock market and not even try to do better? Active investors feel that if you’re smart enough and willing to spend time doing homework, you can exceed 10 percent annual returns. Active investors also find investing to be thrilling, almost like a hobby. Some active investors try to find undervalued stocks and hold them until they’re discovered by other investors. You’re an active investor if you Think long-term averages of stocks are meaningless: Active investors believe they can spot winning companies that no one knows about yet, buy their shares at just the right time, and sell them for a profit. Are willing to spend large amounts of time searching for stocks: These are the investors who sit in front of financial TV shows, analyze stocks that look undervalued, and do all sorts of prospecting trying to find gems. Believe you can hire mutual fund managers who can beat the market: Some active investors think that certain talented mutual fund managers are out there and that if they just give their money to those managers, they’ll win. Suspect certain types of stocks aren’t priced correctly and that many investors make bad decisions: Active investors believe they can outsmart the masses and routinely capitalize on the mistakes of the great unwashed. Understand the risks: Most active traders underperform index funds, some without even realizing it. Before deciding to be an active trader, be sure to test out your skills with online simulations, or make sure that you’re measuring your performance correctly. If you’re losing money picking stocks, stop doing it. Be sure to know how dangerous online investing can be when you’re trying to be an active investor by reading a warning from the Securities and Exchange Commission. Sites for the active investor to start with Ever hear of someone trying to learn a foreign language by moving to the country and picking it up through “immersion”? The idea is that by just being around the language, and through the necessity of buying food or finding the restroom, the person eventually becomes proficient. If you’re interested in active investing, you can do the same thing by hitting websites that are common hangouts for active investors. By lurking on these sites, you can pick up how these types of investors find stocks that interest them and trade on them. These sites can show you the great pains active investors go through in their attempt to beat the market. A few to start looking at include the following: TheStreet.com collects trading ideas and tips from writers mainly looking for quick-moving stocks and other investments. TradingMarkets explores the details of complicated trading philosophies. The site highlights stocks that have moved up or down by a large amount, which is usually something that catches the attention of traders. Seeking Alpha provides news and commentary designed for investors of all skill levels who are trying to beat the market.

Cheat Sheet / Updated 04-12-2023

Make the most of fundamental analysis by getting familiar with financial statements and investment terms as well as knowing the best places to find fundamental data.

Article / Updated 02-07-2023

Various stocks are out there, as well as various investment approaches. The key to success in the stock market is matching the right kind of stock with the right kind of investment situation. You have to choose the stock and the approach that match your goals. Before investing in a stock, ask yourself, “When do I want to reach my financial goal?” Stocks are a means to an end. Your job is to figure out what that end is — or, more important, when it is. Do you want to retire in 10 years or next year? Must you pay for your kid’s college education next year or 18 years from now? The length of time you have before you need the money you hope to earn from stock investing determines what stocks you should buy. Here are some guidelines for choosing the kind of stock best suited for the type of investor you are and the goals you have. Type of Investor Time Frame for Financial Goals Type of Stock Most Suitable Conservative (worries about risk) Long term (more than 5 years) Large cap stocks and mid cap stocks Aggressive (high tolerance to risk) Long term (more than 5 years) Small cap stocks and mid cap stocks Conservative (worries about risk) Intermediate term (2 to 5 years) Large cap stocks, preferably with dividends Aggressive (high tolerance to risk) Intermediate term (2 to 5 years) Small cap stocks and mid cap stocks Short term 1 to 2 years Stocks are not suitable for the short term. Instead, look at vehicles such as savings accounts and money market funds. Very short term Less than 1 year Stocks? Don’t even think about it! Well . . . you can invest in stocks for less than a year, but seriously, you’re not really investing — you’re either trading or speculating. Instead, use savings accounts and money market funds. Dividends are payments made to a stock-owner (unlike interest, which is payment to a creditor). Dividends are a great form of income, and companies that issue dividends tend to have more stable stock prices as well. Not everyone fits into a particular profile. Every investor has a unique situation, set of goals, and level of risk tolerance. The terms large cap, mid cap, and small cap refer to the size (or market capitalization, also known as market cap) of the company. All factors being equal, large companies are safer (less risky) than small companies.

Cheat Sheet / Updated 12-08-2022

The nascent world of modern decentralized finance (DeFi) has grown rapidly since the advent of Bitcoin in 2009. Read on for helpful tips on how to navigate this exciting new realm.

Article / Updated 12-02-2022

It may not be obvious to many people how disruptive and game-changing factor investing is to the long legacy of hot shot money managers that are to Wall Street what celebrities are to Hollywood. You see, by isolating and identifying key characteristics that define outperforming investments, factor investing puts you on the same elevation as the professional money manager, giving access to a selection process once attributed to managers’ exclusive stock-picking prowess. This holds out the promise of market-beating returns without having to pay high fund manager fees. The entire field of factor research has been a giant pain in the backside for overpriced money managers, even ones who have had market beating runs. In previous decades, a successful fund manager was simply assumed to be performing due to his stock-picking expertise, and many assumed almost god-like status. Bookish academics have inadvertently undermined these market legends by demonstrating that, with very few exceptions, winning stocks shared key factors in common and these factors could be used in advance to pick a winning portfolio. In fact: Currently, factor models can explain up to 95 percent of the differences between active managers, an attribute formerly ascribed mostly to manager skill. Factor investing offers the potential to achieve market beating returns without high manager fees, saving you money! Factor investing put the exclusive tools of professional money managers at your fingertips, but to work, you need to use them efficiently and with discipline. Factor-based (or smart beta) strategies are gaining popularity and market share, competing with index funds (passive returns), and traditional manager (active) returns, as shown in the figure below. Navigating the Factor Jungle More than 300 factors have been discovered in recent years, but not all pass the feasibility test. Here’s how you define a good factor: Did it outperform (make money!) in the past? Will it make money (net of costs) in the future? Why does it work? (The answer to why helps you answer whether it will make you money, and also whether the effect might be already duplicated by another factor that already contains the elements of another factor.) As factor investing gains popularity, it becomes even more important to do your own research and answer these three questions. You would think the academic spotlight now aimed at this field would make things clearer and better defined, and in many ways it is. What surprises new investors is what John Cochrane of the University of Chicago warned is becoming a zoo of factors. Factors are becoming so numerous and exotic that investors are confused by the sheer proliferation of discoveries (one hedge fund claims to use over 80 different factors in its stock pickings!) Keep your strategy simple and focus on the proven factors, and the stocks, mutual funds, and exchange-traded funds (ETFs) that incorporate them. Avoiding the Factor Zoo So why are there so many factors to choose from? There are many reasons, but most of them break down to one of the following: A newly discovered factor works because of attributes that are already integral parts of an existing factor. Or, the factor is really a phantom result of poor statistical analysis and/or outdated or incomplete historical stock price databases. Answering the three questions above helps you determine whether a factor includes the right attributes. Avoiding supercomputer factors Supercomputers crunching numbers can be both a blessing and a curse. The details are beyond the scope of this book, but if you're interested it's worth reading more of what professor Cochrane has written about this. In short, the dangers of data mining and selection bias can cause very smart people to come up with powerful factors that aren't very profitable: Data mining: The process of analyzing dense volumes of data to find patterns, discover trends, and gain insight into how that data can be used. Selection bias/survivorship bias: Caused by choosing non-random data for statistical analysis; for instance, back testing a factor's historical performance against the pool of all existing small capitalization stocks inadvertently eliminates just as many stocks that are no longer trading as they've gone bankrupt or merged. For example, the chart below shows what percentage of stocks that were trading in the past are now delisted versus what percentage are still actively trading. Clearly, any factor would have to have outperformed in the real world that included these defunct stocks and not just when run against a database of currently existing stocks. Seems obvious in retrospect, but many factor discoveries have proven to be based on incomplete or biased databases. Computers are only as good as the data you feed them. A huge number of factors that seem to work on historical data models do not pan out in the real world for various reasons. These factors are the product of powerful computers searching through enough data to find a situation where a new factor looks good by sheer accident and randomness. Of course, you want to avoid these factors because they don’t have the predictive power for the future and won’t bring you success in the future. The risk of using a factor from the factor zoo isn’t just underperformance, but also the trading and management fees it costs you to carry it out. In addition, there's the opportunity cost to you had you done something more effective with your money! Finding investable factors Literally hundreds of factors have been discovered and analyzed in recent years (see the sidebar for some examples). Many of these factors work on paper, but to be useful for you in your investment strategy, factors need to clear a much higher bar. Some factors only work in certain decades, or with a specific sector of the stock market. If a factor can’t duplicate its outperformance in other decades and over long periods of time, it's not really investable. An investable factor also needs to yield enough expected outperformance that it outearns the amounts you pay in costs, fees, and taxes: All portfolios, no matter how efficiently run, have trading and operating expenses, and all investments have a buy/ask spread, meaning that you lose a little money simply transacting a buy or sell when it's needed to follow the rules of any particular factor. Unless you’re holding your portfolio in a tax-sheltered account such as an IRA or a 401(k) (many now offer the ability to trade individual funds and stocks), there are potential tax costs for executing any strategy. You especially need to account for taxes if you’re using a high turnover factor strategy where gains are likely to be taxed at the less favorable short-term capital gains tax rate than the more favorable long-term capital gains rate. When we distill these ingredients to their essentials, some basic rules emerge. These three things make a factor attractive: Doggedness: The factor must show up through different time periods and not just one random decade or period. No one-trick ponies here. You want factors that persist for any investing period, given enough time. Prevalence: The factor must demonstrate an advantage with various different countries and market sectors. Investability (actionable): The factor must be able to be deployed cost effectively (costs include trading fees, taxes, and potentially time/research efficiency for more esoteric factors). Factor outperformance is cyclical, yet hard to time. One factor is always leading the pack and your odds of guessing which one is negligible. Morningstar, a leading investment analytics company, has studied factor investing extensively and concluded that factor investing offers the promise of: Improved absolute returns (more gains!) Improved risk-adjusted returns (gains with less risk and a smoother ride than other approaches!) Extended periods of outperformance followed by droughts (long periods of underperformance relative to whatever cap-weighted index you’re trying to beat) When using factors, you must stick with your strategy to earn the rewards! There will be times when you feel like bailing! It’s best to wait for the historical outperformance of solid factors to materialize. Any attempt to time a factor approach requires skill and probably adds additional headwinds of trading costs and tax inefficiency (unless you're doing it in an IRA or tax-favored account). Even the best factors experience periods when they underperform the market, and these are hard to predict. You need patience to let a factor work for you. You need to stay in it to win it! The key is, of course, to diversify factors in your portfolio.

Cheat Sheet / Updated 11-10-2022

Factor investing helps maximize your odds of being a successful investor in many ways, including helping you control and avoid self-defeating investor behaviors. Understanding the behavioral finance aspect of factor investing, as well as how great investors have dealt with it in the past, can make you an even better investor.

Cheat Sheet / Updated 10-21-2022

Are you surprised that it's so hard to consistently earn money on the stock exchange? The explanation is as simple as it is sobering: It's because we are all human beings, with all the associated genetic dispositions that come with that fact. The neural structure of the human brain is the result of our evolutionary development. Your thought and behavior patterns, such as the deep-seated fight-or-flight response, continue to influence your decisions today on the financial markets. Your nature is not particularly well-suited to trading, but you can learn to do it. The human brain is capable of change and development. You can learn the mental prerequisites for brain-compatible trading. With the right mindset, you can recognize and avoid errors before they occur. The innovative discoveries of modern neurofinance research will lead the way to success factors for brain-compatible and, therefore, successful trading.