Investing in the Stock Market -
for a Start... or for Life

For many of us investing in the stock market is both the starting point and a life time destiny. No wonder: stocks offer the easiest possible way to invest in the success of companies - or even of entire countries! Stocks are also available for a wide range of investors - from small to very large amounts, and at low transaction costs. Investing in the stock market is certainly not the only way to invest, and neither is it necessarily the most profitable. Yet, it does offer a hard-to-beat combination of advantages. No wonder it is so popular among investors.

Stock Market

Investing in the stock market typically results in 7-8% annual returns over the long term, although this varies wildly from year to another. This variation - also called volatility - is the main reason why your stock investments should always be for the long term. With any bad luck the returns can be deeply negative over any short period. Over the long term though - say 5 years or longer - the risks of losing money are smaller and the chances of doing well rather high.

Naturally the method you select for picking your stocks makes a difference, too. You may be beating the market with a wide margin (not probable but possible!), if you use a good method for your stock picking. On the other hand, you may tend to lag behind the market most of the time. Unfortunately this is the most typical scenario for people investing in the stock market - and of course the one for you to avoid!

Charts Rising

There is no shortage of advice for investing in the stock market. The challenge is that most of the advisers get paid for just giving the advice or selling a related investment service, rather than for the success of the advise. The advisers seldom have really "skin in the game", and many of them can't demonstrate success in managing their own investments. Due to all this, most of the advice is useless and some of it even harmful. Regarding the part that is genuinely useful and profitable, part of it not practical, as it requires more knowledge and time than what most of us have. To make it worse, it is often hard to know in advance what really works and what doesn't - and by the time you find out, you may already have wasted much of your time and a fair bit of your money too.

Analyzing Stocks

Through tons of time, effort, several failures, and then some major successes, I have found four methods that seem to work well in investing in the stock market. I will first briefly mention these methods and then come back to each of them in a separate paragraph. I'll start with the easiest and least time-consuming way of investing in the stock market: low-cost index funds. Yes they may be mundane and boring but really give you your money's worth! However, if you insist on doing your own stock-picking, there are three further methods left. You have Joel Greenblatt's "Magic Formula" method that he explains fully in his "Little Book That Still Beats the Market". You also have the long-term value oriented "Graham-Dodd" school of stock-picking methods used by Warren Buffett, among others, explained in Ben Graham's book "The Intelligent Investor" and described also in Robert G. Hagstrom's book "The Essential Buffett". Finally, you have numerous investment newsletters that pick and recommend stocks. They choose their picks on the bases of fundamental - and other - analyses of various kinds and give you the final word in selecting and buying the stocks you like the most.


Index Funds - a Great Start... and Finish

Mutual Funds

If you know nothing about stocks or don't have much time to devote to analyzing them, low-cost index funds may well be your ticket to investing in the stock market. Even if you know a lot but haven't really found anything that works well for you, again the good old boring index funds may be what you are looking for. They are just a real work-horse for stock market investments and offer tons of value plus take almost no time at all to manage. Best of all, they beat the vast majority of other mutual funds year in year out and even more so over the long term. Low-cost index funds are very easy to buy, hold, and sell, and widely available. They also offer an opportunity for some level of specialization or focus: if you are convinced that some particular segment of the market - say small companies or a stocks in a particular country - will be a sure winner, you can go for a fund that tracks an index that focuses on that segment or country. Or if you really want to minimize your effort and spread out your risk, Alexander Green's index fund based "Gone fishin' portfolio" could be something seriously worth considering. Whatever you do, though, just make sure you select index funds that have no (or very low) entry fee, very low annual fees, and certainly no exit fees. Among the most popular providers of low-cost index funds are Charles Schwab, Fidelity, and Vanguard.


The Magic Formula

J. Greenblatt - The Little Book That Still Beats The Market

Joel Greenblatt, professor at Columbia Business School and managing partern of Gotham Capital, is a rarity. He is one of the few people who has come up with a documented stock picking method that both works and is feasible for the non-professional or part-time investor to use. He explains the research, details, and results of his method in his "The Little Book That Still Beats The Market" - a great book that delivers what the title promises, unlike many others of the same kind. Research shows that Greenblatt's methodology, called "The Magic Formula", amazingly keeps beating the stock market indexes. The method is proven to work well over mid and long term - over investment horizons of 3 years or longer.

Greenblat's book is thin and light to read - his style is humorous and text easy to understand. If you really want to pick your stocks yourself but cannot devote much time to it, this might be just be the thing for you. I warmly recommend to read the book, look at Greenblatt's web-site, and then decide if this is your thing for investing in the stock market.


Stock Analyses and Picking - All by Yourself

Warren Buffett

Are you strong in finance, have a lot of time in your hands, and aren't afraid of rolling up your sleeves for some serious financial digging and number crunching? If so, you may want to do what Warren Buffett does and use the "Graham-Dodd" methodology for picking your stocks. In brief, this methodology focuses on identifying and analyzing fundamental characteristics that make companies great investments and attempts to find companies that are winners in the long term.

Graham's book "The Intelligent Investor", while written already long ago, is really timeless in its philosophy and explains to a great level of detail the principles of this methodology. To get a more recent and somewhat modified take of the same, you might also want to have a look at Robert G. Hagstrom's book "The Essential Buffett". Finally, Warren Buffett's letters to the Berkshire-Hathaway shareholders - besides being fun to read - give a great practical view of the results of this method and Buffett's investment philosophy. This is a great method of picking stocks but requires a lot - really a lot! - from the person applying it. It won't work well unless you do all your homework properly - really all of it. Yet, if you do it well, there are few better ways to make money in investing in the stock market.


Stock Analyses and Picking - With Help from Pro's

Newsletters

If you do want to pick your stocks yourself and like the fundamental analysis approach but need someone else to do the legwork for you, one of the many investment newsletters might be what you need. There is a real plethora of newsletters out there. Most of them are available on-line and look and feel very professional. All of them will claim to make money for you much beyond the index they benchmark themselves against. With all this, it may feel really hard to decide and choose the one to use. Luckily, a service called "Hulbert Interactive" tracks the long-term success of investment newsletters and can help you to choose the service that suits you the best. Hulbert's service is widely recognized and probably the best of its kind. The prices of investment newsletters vary a lot, but in general they aren't expensive. An annual fee of $100-200 is typical - and the more expensive ones don't necessary deliver much better results than the lower-cost ones.

My personal experience of some of The Mottley Fool brand of investment newsletters shows that they are mostly successful and tend to do the job they are claiming to do. I say "mostly", because they have had their ups and downs like any service of the same kind. Investment newsletters are only as good as the analysts or stock-pickers behind them - so follow carefully who is editing your newsletter, and if the editor changes, also the performance of the letter will probably change. Up to you to decide, of course, what action to take in such a case. If you decide to pick this approach and use an investment newsletter for your stock picking, you could do worse than take up a subscription at Hulbert Interactive - you get one month for free! - and use it for picking up the newsletter that is the best one for you.


Get Started - Invest in Stocks!

Dream of a Fortune

Investing your regular savings or other incoming cash flow in the stock market is the most popular way to invest, even if there are others that may have still higher potential for profits. If you don't have anything clearly better in your mind, stocks may just be the place for you to get started with your investments. If you later on find better ways to invest your money, you can always sell your stocks - or some of them - and invest the proceeds to whatever better vehicle you have found: your new start-up business, a part-ownership in some-one else's company, or anything else that you go for. And if you eventually decide to stay in stocks, no damage done - you'll be in good company! Stocks are very liquid, don't necessarily require much commitment, and take little time to manage. Investing in the stock market can be great way to build wealth over the long-term and offers a combination of advantages that makes it hard to beat.

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