Jeff Bezos: Warren, your investment thesis is so simple. Why doesn’t everyone just copy you?
Warren Buffet: Because nobody wants to get rich slow.
When most people think investing, they think investing in the stock market. In the long run you’ll always come out ahead, provided you live long enough. So let’s see if we can come up with the best way to invest our money.
Most people think they can beat the market. But what does beating the market even mean? When people say the market, what the really mean is the S&P 500. The S&P 500 is known as an index, and it’s simply a list of 500 well-established companies. As a whole, these 500 companies represent a snapshot of our economy. Instead of analyzing the whole market, which is damn near impossible, analysts wanted to look at a smaller sample size, thus the S&P 500 was invented. So if the S&P 500 grew by 10% this year, and your personal investment account grew by 11%, you have successfully beaten the market. So do people actually beat the market? No. No they don’t. Maybe for a couple years, but not consistently over decades. Only a handful of investors have continuously bested the market year after year, one of which is Warren Buffet.
Slight history lesson. So for the longest time normal people would buy stocks and hope they got lucky. It was hopeless. It was basically gambling. No one had enough money to properly diversify their portfolio. You’d put all your money into one or two stocks and when they flatlined you lost everything. So investment firms invented something rather brilliant, a mutual fund. So you and everyone else put your money into the fund, and the fund manager uses the money to buy all sorts of stocks, hundreds of different stocks. So now everyone has successfully diversified. The highly-trained and extremely-smart fund manager selects which stocks to buy and sell, and you don’t have to worry, you just have to pay a small fee. Everything was fine except…
The fund manager wasn’t so smart, and the fees weren’t so small. While people did make good money, the problem was no mutual fund ever out performed the S&P 500. So eventually one man came along and said this is incredibly stupid. If no fund manager can pick stocks that outperform the S&P 500, why doesn’t the fund just only contain the 500 stocks on the list? Duh! That man was John Bogel, the founder of Vanguard. And he created the first index fund. It’s like a mutual fund, but the stocks are pre-selected to match the index. There’s no need to pay fees to a fund manager because there ain’t shit to manage. And its returns are better than any mutual fund out there because 99.99999% of investors cannot beat the market. You’re better off just being the market. So we’ve established that if we’re playing the long game and planning for retirement, index funds are the best way to go. Simply put your money in and let it ride. It may be boring, but it’s easy and effective. There is another strategy out there I want to bring up:
The main difference in investment strategy between a rich person and a poor person is when the economy crashes and enters a recession, a poor person sells their shares while the rich person buys more shares. I cannot express how important this is. The poor person has stretched themselves too thin, and now needs to withdraw their money from the market to help pay for rent during the troubled times. They put $1000 in the market, only to see the market crash a year later. To pay their bills, they withdraw their money when it’s now only worth $500. So not only did they lose on their investment, they lost all future potential from that investment. Double loss. And do you know who they are selling those stocks on the cheap to? The rich dude! Because the rich person has money laying around and can capitalize on the situation. The person who is already wealthy is getting the deal of a lifetime. Moral of the story: you need money sitting on the side to capitalize on situations.
This is counterintuitive to what many experts and investment books advise. They tell you to invest your money right away and start compounding that interest. Screw them. Now I know most people get antsy and don’t like sitting on their money for perhaps years at a time, but it can be worth it. Don’t go betting on random stocks you think might hit, just wait for the opportune moment. Trust me, there will be plenty of moments.
The easiest moment to wait for is when the market crashes. That may seem like a long time to wait, but the market goes in cycles. During my own short life time: the market crashed the week I was born (known as Black Monday), that was followed by a tech bubble, then 9/11, then a housing bubble, then a pandemic. So in a perfect world you would have put your entire savings into the market after the first crash. Then you would have gone to work and continued to set more money aside. And then when the market crashed for a second time, you invest everything you had saved up so far. And then repeat the cycle again and again, with no need to do any other type of investing. I’m confident in saying you’d be rich.
Now you don’t need to only wait for the whole market to crash. You can also wait for individual companies to crash. Not random companies, but well-established companies. Remember when Chipotle had an E. coli outbreak and their stock plummeted? A sane person would’ve looked around and been like “um… Chipotle’s not going anywhere” and then bought their lower-priced stock. Remember when Toyota had a recall on their brakes? Remember when that one CEO got caught saying something racist? You’re probably thinking “which racist CEO, there were so many” and that’s the point! The stock of well-establish companies goes down all the time, for something that company can easily overcome. So just wait for them to screw up and then pounce.
You might be asking why are other people even selling their stock? Why are they panicking? Don’t they know the company will just keep on trucking? Why withdraw in a down market? Good question, and it has several answers. First, as we established some people are poor and need money asap. Second, most investment money is controlled by fund managers. They are judged every quarter on their performance, so they don’t want to take any short-term losses that make their numbers look bad, even if they know the best play is to hold and wait it out (another reason why you shouldn’t be in a mutual fund). Third, some people are about to retire, and even though they know the stock will recover in five years, they’re not willing to wait that long to cash out. And fourth, people are stupid.
So a very effective investment strategy would be to put half your money in the S&P 500 index fund, and then keep the other half in a high-yield savings account, waiting for a disastrous event to happen in the market. There are a few things to keep in mind along the way.
There are unlimited gains to be made in the stock market, and only limited loses. You can only stand to lose what you’ve invested, but there is technically no ceiling for how much you can earn. The only way you can truly lose in the stock market is if the company you bet on goes bankrupt, otherwise you’d just keep holding onto the shares indefinitely until the company turns it around or is bought out by a better company. So when investing, if you think the company has a chance of going bankrupt in the foreseeable future, watch out. This is why startups are so risky.
You are going to want to reinvest your dividends. This is key to growing your portfolio. There are two ways to reinvest dividends. The first, you don’t have to actively do anything, when you buy a stock or an index fund just click the reinvest dividends checkbox. So let's say you have 100 shares of a $50 stock. The company gives you a $1 dividend per stock, so that’s $100. That money is automatically reinvested, which buys you two more shares of the same stock. Next year you have 102 shares and will receive $102 in dividends to reinvest and do it all over again. This method is easy because you set it and forget it. Now the second method involves actively spending those dividends. Instead of auto-enrolling and buying the exact same stock, it might be more beneficial to buy a different stock, especially if the auto-stock is at an all-time high.
Stay away from stock recommendations from all those online articles and so-called experts. Even the more legitimate ones are still scamming you and here’s how: That expert buys a bunch of shares in some company. Then the expert publishes an article about why that company is the next big thing. Then all the readers go out and buy shares in that company, driving up the stock price. The expert cashes out his investment, pocketing the profit margin. And the readers think the expert is a genius and keep following his advice, when in reality that stock is only experiencing a temporary spike and might be garbage.
The most important decision when you retire is when to pull out all your investments. What if you turn 65 and retire in the middle of a recession? You’re stock portfolio isn’t looking too good at that particular moment. You’ll probably want to wait a couple years to withdraw the money, so make sure you have enough on hand to survive that long. Don’t ruin decades of smart investing only to withdraw your money at the wrong time.
When you withdraw your investments, you’ll have to pay taxes, it is income after all. The kind of tax you pay is determined by whether it was a short term investment (under 1 year) or a long term investment (over 1 year). Short term investments fall under your normal income tax bracket. So if you made $60k from your normal salary and sold stocks that year worth $90k, you would be in the $150k tax bracket. So that extra income you earned through trading stocks would be subject to a very high tax. But long term investments are subject to a different tax bracket, one that has much much much lower tax rates. Another reason why long term investing is the smart play.
Now I’m not against investing in a startup company and trying to bet on the next big thing. It’s certainly fun, and it’s most likely the only way to make you truly filthy rich. But it is super risky. But if you got a good feeling about something I won’t stop you. There was this fund manager, one of the few successful ones, who bought a lot of his stocks based off his wife’s shopping habits. She was very in tune with what was upcoming and what was hip, she always seemed to be at the forefront of trends. I also remember as a kid I got Netflix, back when it was only DVDs, and even then I was like “well this is here to stay.” I also remember as a kid when Microsoft announced the Xbox and I should’ve ran to my parents and said “Microsoft is getting into the video game industry and every kid at school wants one!” I also remember my first Chipotle burrito. Moral of the story: pay attention to your spouse and kids.
I feel compelled to mention bonds, the least sexiest of all investments. Bonds are basically a loan. Banks and corporations can issue bonds, but most bonds are done through the government (known as Treasury bonds). You give the government money, and after a set time frame, they will return the money plus interest. For instance, the government might say: give us $500 and in ten years we will give you back $1000 guaranteed. Bonds do not generate a very high interest rate, but there’s much less risk. The government can never go bankrupt, they just print more money like a boss, so you will always get your money, which is why most people do treasury bonds. Banks and corporations might give you a slightly better interest rate, but they could always go out of business. The downside with bonds is that you are locked-in, you cannot withdraw your money (unless you pay a hefty penalty). You must wait for your term limit to end. There are index funds for bonds too.
So a good investment strategy is to invest in stocks when you’re younger and bonds when you’re older. Basically more risk/reward when young and more small but guaranteed when old. The idea being if you’re reaching that retirement age, you don’t want to have all your money in stocks if a recession is on the horizon. When you’re older you’re no longer in the growing wealth game, you’re in the wealth preservation game (hopefully).