There are two reasons why novice investors feel defeated by the stock market:
Technology can make investing easy and fun. It is now extremely easy for an individual to start investing, with as little as $5. Apps have gamified the investment process — likely with the good intention of using colors and graphics to make investing less scary and more welcoming to a younger generation, but perpetuating the idea that the stock market is a game with winners and losers. Experts online claim that day-trading is a complex but surefire way to make money, and anyone can rake in thousands of dollars as soon as they buy a special course.
Picking individual stocks is simply not a winning strategy. Studies have shown that most active managers (people who get paid hundreds of thousands of dollars to pick winning stocks) have historically underperformed the market. Here are a few reasons why:
Does this go against what you’ve heard anecdotally from acquaintances who claim to have bought Amazon stock in the early 2010’s or who have gone “all in” on Tesla or any one of this year’s hot stocks? Sure, a short-term trader can make money – for a while, by sheer luck. People have lost all their savings by betting on or against the next big thing, be it tech, or pharma, or even telecom.
The answer to stock-picking: Diversification
Proper diversification of your portfolio is key to your investing success over the long run. By investing in many companies at the same time, you hedge your chances of failure. Even if a company fails or an entire sector fails to perform, your portfolio will be relatively intact. Most people buy ETFs (Exchange-Traded Funds) that offer diversification for a low fee. You should also only invest with money that you will most likely not need for 5-10 years. That gives your investment the chance to work for you over the years as your returns compound over time. Diversifying your portfolio by investing in low-cost ETFs has several advantages:
A bet on the US (and global) economy: The S&P 500 consists of the 500 biggest public companies in the United States. Other indexes, like the S&P Global 1200 (which captures 70% of the global equity cap), and Russell 3000 give investors more options to bet on the overall economy.
Lower trade fees: Buying and selling stocks to build a portfolio can be costly in terms of trading fees and commissions. However, most investment platforms offer access to their own S&P 500 index fund for no fee.
If you do want to trade individual stocks, it is possible to do so in a well-diversified portfolio. It is best to set weight limits on asset classes within your portfolio, perhaps something like this:
Good financial planning should be a bit boring. Decide on your financial goals, build an aligned portfolio, and then let your money grow over time. Not only does this keep costs low and save you extra work in tax season, but it also allows you to avoid knee-jerk reactions during periods of high volatility.