How to Avoid Losing Money in the Stock Market
Hey everyone,
This newsletter is supposed to cover “code, money and self-improvement,” so I thought it was time to start writing on personal finance.
I’ve been thinking about investing this week because of a conversation I had with a family member. This person mentioned to me that they didn’t want to invest in the stock market for fear of losing money. With that in mind, I wanted to outline what I consider to be a near-foolproof investment strategy based on the last 100+ years of market history.
Caveat 1: I’m aware that it may come off insensitively to talk about investing given the current state of the world. Of course, I feel for anyone that’s been negatively impacted by the coronavirus. And I totally understand that a lot of people are focused purely on surviving. These thoughts may not may be for them right now, but I think the principles still stand despite how chaotic and uncertain life feels.
Caveat 2: I’m far from the first person to write about this. In fact, most of what I’m going to write was inspired by The Simple Path to Wealth, which I recommend to anyone looking to learn more about this particular approach to investing.
So, here’s the strategy: invest consistently over a long period time in broad-based index funds. This is why the strategy works:
When you buy a share of an index fund you’re buying a piece of the American economy
I think there’s a tendency to imagine that when you buy a stock, you’re converting money from something certain into something uncertain. However, what you receive in exchange for your cash is not something random and ephemeral, but a small slice of the U.S. economy.
When you buy a share in an index fund, your money is then able to make money for you in the market, which over the past century has averaged about 7% annually. The average savings account pays a fraction of a percent, making index funds the clear winner as far as gains are concerned.
It’s good to buy pieces of the U.S. economy because it has always gone up over time
What if the market goes down? It’s a common question. That said, you only truly lose money when you sell. The fluctuations of your preferred index on any given day aren’t necessarily reflective of the actual value of your shares.
The important principle here is that, long-term, the market always goes up. Think about it: can you imagine what life would look like if over 30 or 40 years the market didn’t average any growth? We’d have much bigger problems on our hands than investment returns. Even if there’s a big dip for a while (like in the Great Depression or Great Recession) our market has always recovered:
The reason for this is that our economy is predicated on consumption. (This video from Ray Dalio explains that better than I ever could, and I highly recommend it.) So remember: the market trends up.
Because the economy trends up the focus should be on starting early and being consistent
The saying goes that it’s about “time in the market, not timing the market.” Assuming point #2 is true, consistency across time triumphs over our human impulse to buy when the market is rising and sell when it’s declining. Because of compounding, the best investment decision is to start early and stay steady.
Of course not much in life is for certain. But if the last century of U.S. markets are any indication of their future, then this strategy is the best way I know to enjoy consistent stock market gains, even in the time of coronavirus. I hope you find it helpful!
Pete’s Picks ✅
Blog: I’ve been enjoying the Farnam Street blog and podcast. Named after Berkshire Hathaway’s address, FS “helps you master the best of what other people have already figured out.” FS has a focus on mental models, which I’ve found helpful.
Podcast: I binged the whole series Wind of Change this week. It covers a conspiracy theory that the CIA wrote a pop song to help end the Cold War. Absolute banger.
YouTube Channel: I’ve loved watching Yes Theory this week. Yes Theory is like a really sincere form of Jackass—the three main characters are constantly pushing their comfort zones, but often for the benefit of other people. Highly recommend if you’re looking for a nice distraction.
Cheers,
Peter