Tuesday, September 28, 2010

Investing For Dummies

I had a conversation with a good friend recently during which I realized that he basically had no idea how to even begin interacting with the stock market. The people who read this blog are definitely spread across the entire spectrum in terms of investing acumen, with a few being professionals in the financial industry and others likely to have never owned a single investment vehicle in their entire lives, with the possible exception of their 401Ks. This post is aimed at the second group, as I'm somewhere in the middle (extremely far from either end actually) and seem to get by just fine with just ETrade. So here are my ground rules:

0. Before you invest on your own, contribute however much your company will match to your 401K. This is free money, yada yada yada, just do it. Also you should have a Roth IRA that you put the allowed $5K into every year, because "Roth money is the best money". If you're unclear on either of these points, let me Google that for you.

1. Keep it simple. If your "plan" gets extremely complicated or your portfolio gets jumbled, you're likely to either throw up your hands and lose interest or end up making a bunch of trades to try to fix it. Neither is a particularly good result. So above all else when you're just getting started, keep it simple. The best way to keep it simple is to own as few things as you possibly can.

2. Use ETFs. They trade like stocks and are low cost, and if you buy in large enough chunks the transaction fees (which are fixed) should be more than offset by the lowered expense ratios. Most of the ETF's I own have expense ratios around .1% for domestic equities and .25% or so for foreign stocks (mutual funds that strive to mimic the same indices often have fees 3 to 5 times higher).

3. Pick an asset allocation and track it in a spreadsheet, updating the numbers once every few months (or if you have a job that actually ensures that the amount of money you have consistently grows, whenever it is that you have money you'd like to get invested in the market). Investing yourself isn't as easy as turning on your 401K and letting it go; you have to actually click "buy" and decide how much and when. Having this sheet showing how you're doing against your desired allocation will make it easy to decide what to buy. Don't get bent out of shape if you're off your desired allocation either, so long as you're somewhere in the right zip code.

4. My current "desired" allocation is 30% large cap domestic equities, 15% medium, 15% small, 20% "Europe and Asia", 10% emerging markets, and 10% bonds. This is spread across all my accounts (which I'm currently condensing from 3 down to 2 by rolling my old Oracle 401K into my Roth IRA) and is pretty much a basic allocation plan for someone who is young, has many years of earning ahead of him (debatable in my case I realize) and is not specifically saving for anything except "retirement". If you get out of whack by more than 1/3rd (so your 15% investment falls below 10% or above 20%) you should consider trying to "fix it", but again don't get too worried about it.

5. When you have some money that you'd like to invest, pick a vehicle and get started. With ETFs you pay a fixed cost each time you make a transaction, so in general this first step can be either expensive or leave you owning like only 1 or 2 things. That's ok; having a poorly balanced portfolio is better than not having one. If you only buy say two things to get started, then 6 months later or whatever you can add a 3rd, then a 4th, and eventually you'll have yourself something reasonable that works for you. My rule of thumb is never to buy less than $5,000 worth of an ETF, and ideally to shoot for twice that. The last year or so has been trying, however, and I haven't really bought anything during that time. This 401K rollover has me touching my money for the first time since mid 2009 actually (other than selling some stuff that one time to not busto myself while I worked at HG).

6. When I actually buy the investment vehicle I find it useful to use ETrade's limit order interface. Basically I decide what I'm going to buy, look at the current price and set my price something like .5-1% lower than the current ask. So yesterday I bought something that was trading at 114.80 and put in the bid at 114. It filled this morning when the market dipped and I at least feel like I got a decent price.

7. I currently only own six (6) things. I have done this by picking index ETFs that fall in the "blend" category. The link explains basically that there are three types of funds; value, growth, and blend. If you don't have a ton of money and want to keep things simple, it's easiest just to buy blends, which are hybrid of value and growth. Anyway, the things I own are:

In essence a domestic large cap, mid cap, and small cap, a "world stock", an emerging markets, and a bond fun. That's it. If you want to own individual stocks that's great; this post wasn't really aimed at you. If you just want to get yourself going with the stock market, these steps should help you get started.


justin7 said...

Jesse, great post. Have you looked at Fidelity as a broker? They offer commission-free trades on many of the most commonly traded ETFS, which can really help if you're getting started or actively rebalancing.

Their list of ETFs is here:


jesse8888 said...

Yes I considered going to Fidelity but in the end my good experiences with ETrade customer service and UI really kept me there. I actually rolled my 401K from Fidelity to ETrade, and this "rebalance" really was only two buys. Had I known Fidelity had commission free trades I might have looked harder at it.

Mostly it's the same reason I bought another Toyota after my Camry died. I test drove the Honda and while it might have actually been better all the shit wasn't where I expected it to be and I just wasn't as comfortable.

Danielle said...

+1 for the ETrade customer service and UI, but it's great that Fidelity is offering so many iShares ETFs as commission-free.

Dan said...

You have done a lot of homework on this, Jesse. Impressive. One point of contention would be to consider active managers for small-cap investments. There's a lot of not-readily had information FTFs are a fine choice.

Have you considered investing in private enterprises that aren't correlated to the stock market? IMO, there's more than one way to experience growth on your money. Even if you took part of your allocation/savings and bought a small piece of an income-producing business, you would have a stronger allocation IMO.

justin7 said...

Yep, ETFC is a fine choice particularly once you're investing more money -> the commissions are not as big of a rake.

Fidelity also has a 2% cash back on everything credit card, which is pretty boss, especially when you can put your rent on your credit card...

jesse8888 said...

Wow Justin that is dominant. At Manhattan rent prices that saves you, what, like $20K a year ;) ?

justin7 said...

Hehe, I can't imagine dropping 80k a month on rent. But hey, something to work towards. :)

jesse8888 said...

We all need goals.

brian said...

Any thoughts on John Paulson's call for double digit inflation and massive increase in gold prices by 2012? Would pretty much pee all over the bond market. With his nice collection of gold, it would appear to some that he is trying to add a few bucks to his pocket.