How to invest (for absolute beginners)

March 01, 2021

Disclaimer: I am not a licensed financial advisor. This article is for informational purposes only. It is not intended to be investment advice. For investment advice, consult a licensed professional.

S&P 500 30 years Your best investment - over 30 years

Investing your money is not hard and there are ways to make it safe. If you are not investing now, learning how to do it is probably the quickest way to increase your income. By the end of this article, you should have actionable steps that will allow you to start safely investing. With an index fund (your best basic strategy), you can expect to see $1,000 become $2,000 in approximately 9 years. In 30 years, you can expect that same $1,000 to grow to over $10,000. This works no matter how much money you invest. So if you only invest $250, you can expect that to become $500 in 9 years. The best part is that this doesn't require you to actively monitor the stock market or change much in your daily life. It also doesn't require you to pay a financial planner or, worse, any internet scumbags.

This article is long. For your benefit, it might make sense to skip directly to the index fund section. If you also want to know how investing works, what stocks are, why bitcoin is dumb, and why index funds are probably your best option, continue reading. If you think you're hot stuff, you can skip to the advanced-tier section.

Note: I wrote this for an American audience. However, most of what you learn here can be applied in your own country with modifications. For more on that, see the international considerations section.

Basic FAQ

Who can invest? How much money do I need?

There are no real legal requirements to invest and you don't need much money either. If you have more than $100 saved up, you have enough to buy at least 1 share of most stocks and bonds.

How do investments work?

Investing is a way to put your money to work. Sometimes your investments make money, sometimes they lose money. On balance, most investments make money. To avoid losing your money, you need to do three things:

  1. Avoid stupid-tier investments.
  2. Diversify (just a fancy way to say "don't put all your eggs in one basket").
  3. Be patient. The market goes up and down. After 15 years or so, it only goes up.

And that's it. Assuming civilization doesn't collapse, you won't lose money if you do all three of these things. And by civilization collapsing, I don't mean stock market crashes, coronavirus pandemics, or oil embargos. These are normal events. Such things happen every few years and have been happening for centuries. After everything, the world economy always comes back just fine. When I say "civilization collapse", I mean nuclear winter, Mad Max gangs, and squirrels-for-dinner collapse.

The world of investments can be divided into two categories, debt and equity.

Mad max scene Your investments only work until the apocalypse

What is debt?

In its simplest form, debt is when you lend money to someone and they pay you back over time with interest. "Interest" just means that you get back a little extra cash in exchange for them borrowing your money.

Types of debt investments:

With debt, you usually receive interest monthly or quarterly (every three months). After several months or years, you'll usually get back everything you originally invested. For other types of debt, the interest payments will simply continue forever. However, even if there is no end date, you can almost always still get your money back.

What is equity?

Equity is when you own something.

Types of equity investments:

As the owner, if what you own makes profits, you are usually entitled to a share of those profits. You are also entitled to sell what you own. If the price of what you bought changes between when you bought it and when you sold it, you make a profit.

What is RoR?

Bear with me. Understanding RoR and doubling times is a tiny bit of math but will help A LOT.

RoR stands for "Rate of Return". RoR is how much you can expect to make from your investment every year. If you invest $100 into something with a 5% RoR, you can expect to have $105 at the end of the year. RoR is sometimes also called the "interest rate".

For debt: The RoR for debt investments is predictable... until its not. For example, you can faithfully loan money to your uncle week-after-week and year-after-year with a 10% interest rate. If one day your uncle gets mauled by a bear with your money in his pocket, well... you're not getting that money back. In reality, bear-mauling usually takes the more benign form of corporate bankruptcy. In these more civilized circumstances, you will often get some of your money back.

For equity: The RoR for equity investments is not predictable and has two components:

  1. The price change of the equity: In the case of stocks, it is incredibly difficult to predict what they will do from one day to the next. Individual stocks sometimes soar and sometimes go bankrupt. However, on average, stocks increase in value over time.

  2. Rent / Dividends: If you own a house that you rent out to tenants, your RoR is the rent you collect + your house's appreciation. When you invest in stocks, you often get "dividends". This is explained in the what's a stock section below.

How do doubling times work?

RoR is simple enough when you are looking at one year. If you invest $100 into something with a 7% RoR, you can expect to have $107 at the end of the year. But what will you have after 10 years? Is 7% a lot or a little?

Instead, it can useful to think in terms of doubling times. If you have an investment with a RoR of 100%, then it has a doubling time of one year. If your investment has a RoR of 20%, then it will double in a little less than 4 years.

Year Calculation Money at the end of the year
Year 1 $100.00 + $100.00 * 20% = $120.00
Year 2 $120.00 + $120.00 * 20% = $144.00
Year 3 $144.00 + $144.00 * 20% = $172.80
Year 4 $172.80 + $172.80 * 20% = $207.36

There's also a simple formula you can use to calculate doubling times:

doubling time =
log(2)

log(1 + RoR)

If you don't know what "log" is, don't worry, your calculator will 😉. Or, you can read about it here.

Example doubling times:

RoR Doubling time
0.25% 277 years
1% 70 years
2% 35 years
5% 15 years
10% 8 years
20% 4 years

One thing to be careful of, RoRs are sometimes adjusted for inflation and sometimes are not. Inflation in the US has been around 2% for at least 10 years and maybe 3% for two decades before that. If your investment has a RoR of 7% before inflation, after inflation it will only be 5%. Whether or not something has been adjusted for inflation matters A LOT.

Inflation US US inflation (from St. Louis Fed)

What if I'm personally in debt or have a mortgage?

If you're in debt, your investment strategy is a harder question. As you probably know, your debt has an interest rate which is usually called your APR (annual percentage rate). Different types of debt have different interest rates. Automobile loans will often have very low APRs near 0%. Morgages and student debt will have higher APRs between 3%-10%. Credit cards tend to have interest rates between 10%-25%. The absolute worst debt are payday loans which can carry interest rates upwards of 300%!

There is a simple rule for debt management. If your debt has a higher APR than the RoR of your investments, then you should focus on paying off your debt. So if you have credit card debt (average APR = 17%), you should not be investing in the stock market (average RoR = 8%) because 17% > 8%. However, if you have a mortgage at a 4% APR, your best option is not to pay off your mortgage. Your best option is to invest your extra money in the stock market. This is because 4% < 8%. It might seem counter-intuitive to not pay off your mortgage but this is actually an effective strategy.

When you are deciding at whether to pay off your mortgage or to invest in the stock market, there are a lot of other variables. This is a place where you should definitely contact your financial advisor rather than trusting me, an internet stranger.

What about retirement accounts?

Some retirement accounts make sense. Others don't. Mostly, they make sense under different circumstances. This article is too already too long so I won't be covering the pros and cons of different accounts. Instead, this article is about what to do with your money outside of retirement accounts.

What's a stock?

Stocks are a tiny slice of ownership of individual corporations. If you own a stock, you literally are part-owner of a corporation. This isn't hypothetical. If you own Microsoft stock, you and Bill Gates have the same ownership rights (he just has a much larger share than you).

As part-owner, you even get the chance to vote on things a few times a year. Most large businesses have stock that you can buy. Some large businesses don't have stock but this is an exception. Each corporation has a set amount of stock. So when you buy stock, you are not buying it from the company, you're buying it from other stock traders. Every once in a while, corporations might sell more stock to raise money. This is surprisingly rare though.

Corporations always try to increase their stock price. This is because, as a part-owner of the corporation, corporate management literally works for you. Their job is to make you money. If the CEO or other board members are doing a bad job, the stock holders (you included), can vote to fire them. These votes are common and your online brokerage will usually let you know when they are happening.

For most stocks, millions of trades happen every day. No single person or organization sets the price of a stock. Instead, it is set by supply and demand. At any time, the "price" of a stock is the last price two traders agreed to. So when you have more people that buy a stock than want to sell a stock, the price goes up. It keeps going up until enough buyers think the stock is too expensive and walk away.

As a part-owner, you are also entitled to the profits a corportion makes. These are called dividends and are usually paid out quarterly (every three months). Dividends flow into your brokerage account without you needing to ask. The RoR of a stock is:

Stock RoR = its price increase + its dividends

You can buy and sell stocks on an online brokerage (explained below).

What's the stock market?

"What's the stock market" is a tricky question. A better one to start with is "what's a stock exchange". There are two main stock exchanges in the US, the NYSE and the NASDAQ. Almost every American stock is "listed" on one of these two stock exchanges. Other countries also have their own stock exchanges.

Stock exchanges used to be literal buildings where you ran around a big floor buying and selling pieces of paper - like in the movies. Now, almost all stock trading is done online and stock exchanges are mostly just glorified lists of stocks and empty buildings.

Inflation US This floor used to packed. Now its mostly empty. (Kevin Hutchinson via wikicommons)

The "stock market" is a generic term used to refer to how stocks are doing in a particular country or region. So, for example, it makes sense to refer to the "US stock market", the "European stock market", and the "Japanese stock market" as separate stock markets. To add to the confusion, often, people will just say "the market".

The "Dow Jones" and the "S&P 500" are NOT stock markets or stock exchanges. These are both examples of a "stock index". A stock index is a collection of stocks that measures how the stock market is doing. In the case of the "Dow Jones", it is 30 massive companies hand-picked to be representatives of the entire stock market. The Dow Jones has a number associated with it at any time. At the time of writing, this number was a bit more than 31,000. This number is calculated by adding up the prices of its 30 component stocks. In reality, the calculation is more complicated but that's the essence of it. So when people say "the market did well today" or "the market is down 4%", they are probably referring to the Dow or the S&P 500.

Why do stocks go up and down so much?

One thing that scares a lot of people is how random the stock market seems. One day, the Dow will be up 500 points, the next, it will be down 800. It swings around wildly even when nothing seems to be happening in the world. Why does this happen? There are three big reasons:

  1. Company news: For most people, this makes sense. If bad news comes out about a company, its stock price will fall. If there is good news, its stock price will rise. News about a company is the primary driver behind big stock price swings.
  2. The market: One reason that stock indicies are useful is because stocks tend to rise and fall together. So if the 30 largest companies increased in price that day, it's likely that the 30 smallest companies also increased in price that day. This is because in the modern economy, every company is tied together in some way. Less demand for dog food means that we don't need as much electricty for the dog food factory. This also means we don't need as many wind turbines to generate that electricty or carbon fiber to build the turbines. So news on any one stock is often meaningful for all stocks.
  3. Noise: Remember that the price of a stock is the last price that two traders agreed to at any one time. Remember also that traders are often irrational people and millions of trades are made every day. With all of these facts, its surprising that stocks don't go up and down more than they do!

What's a security?

A "security" is a fancy word which basically encompasses any tradeable investment. This includes stocks, bonds, treasuries, mutual funds, index funds, etc. Sometimes, "securities" are just called "assets" which is a more general term.

What's an online brokerage?

Online brokerages allow you to buy and sell securities. They are just websites which look and feel a lot like online banking with a few extra features. When you buy or sell a security with an online brokerage, most trades are free.

For your brokerage, you have several solid options:

In the past, I've used TD Ameritrade and Merrill Edge. I currently use Charles Schwab. I've never had anything bad to say about any of them so pick what you like. They should all be fine with one notable exception. I'd recommend against RobinHood because they actively push you into riskier investments. Being a new investor, it would be best to stick with the big established players.

What is the risk / reward tradeoff?

An important concept in investing is the risk/reward tradeoff. The more risky your investment, the more you usually get back if it succeeds. This works a lot like betting odds. If you are betting on the underdog team in the Super Bowl, and they win, you make more money than if you are betting on the favorite. In investing, this works differently depending on whether your investment is debt or equity.

In the case of debt, if a business is risky, they have to promise more interest to get people like you to loan them money. You don't want to lose your money on a business failing and no one else does either. Since businesses need the money regardless, they will promise more and more RoR until they have raised the money they need.

In the case of equity, if a business is risky, its stock will sell for less money. If the business nevertheless succeeds, the stock will soar higher than if it were a safe bet. This is as true for real estate as it is for stocks. For example, buying in struggling neighborhoods with potential can make you more money than neighborhoods that everyone already knows are nice.

Worth noting, risk isn't just the potential of an investment completely failing, its also how much it might go down in the short-term. Stocks go up and down a lot but are one of the best investments you can have - not despite their rockiness but because of it. Not everyone can psychologically stomache the idea that stocks occasionally crash. Because of that, there is more money to be made in them.

All things being equal, the more risk you take on, the higher your (eventual) RoR. But there are reasons you might want to take on less risk. If you absolutely need all of your money next month, you shouldn't be investing in the stock market. If you are planning to buy a house or retire in five years, you probably want a mix of high-risk and low-risk investments.

Different ways to invest

There are lots of ways to invest your money. I've divided the ways into five tiers:

Again, if you are a beginner and want an easy answer, just skip to the smart tier section. The other options are here mostly so I can try to talk you out of them.

1. Stupid tier

Warning: The following will be snarky.

1.1 Savings accounts

TL;DR: Savings accounts are dumb. Only use them if your bank makes you do it to avoid fees.

Quick! What is the RoR of an average savings account? Is it 10%, 5%, 1%? Nope. The average RoR is 0.05%. At this rate, expect to double your money in just under 1,387 years (really). This, of course, assumes that you'll never be hit with a random fee from the bank which could literally wipe out centuries of gains. Worth noting, this is before inflation. So your real RoR is closer to -1.95%.

and its gone Your local banker can help you lose your money faster.

Investment type: Debt

How to invest in a savings account: Consult a glossy brochure at your local branch.

Best case scenario: Your money doubles about 300 years after the Dilithium energy crisis in the Star Trek universe. This is when we can't use warp drive anymore because we've burned all the fuel.

Most likely scenario: You'll lose all of your money in 10 years or so after Wells Fargo opens 9 accounts in your name and charges you a bunch of fees.

Chance of losing big: Almost certain. At best, you will eventually lose all of your money to inflation.

Ease of withdrawl: Withdrawl is easy but you might get charged another fee for daring to access your money.

1.2 CDs

TL;DR: CDs are dumb. There is literally no good reason to invest in them.

What couples the dimunitive returns of a savings account with the inconvenience of not being able to access your money when you need it? That's right! You are thinking of a "certificate of deposit" or "CD". Basically, you are handing over your money to the bank for a few months for goodness-knows-what. Because you give the bank full reign over your money, you get about 10x more than a savings account which is still a measily 0.5% - 0.7%. Your best-case doubling time? That would be 99.3 years.

I can understand why people still put their money in savings accounts. It's there and it's the default option if you don't know any better. Why people still invest their money in CDs is past me. To concede a point, CDs are insured by the federal government so hypothetically they are "risk-free". But you have another option that is also guaranteed by the US government - treasuries! These have a much higher RoR and you can get your money out at any time.

Investment type: Debt

How to invest in a CD: I'm not going to tell you because there is no rational reason to buy CDs.

Best case scenario: Your money will double around the year of 2120. This will be 6 decades after humans develop warp 1 and make first contact but 2 decades before warp 2 is achieved. That was the last Star Trek reference. I promise.

Most likely scenario: You'll need that money during a emergency and will have to pay a penalty to withdraw it.

Chance of losing big: Like savings accounts, you'll eventually lose everything to inflation.

Ease of withdrawl: Very difficult. Your money is locked up unless you pay a fee.

1.3 Cryptocurrency

TL;DR: Cryptocurrency is dumb. A few lucky people who got in early have made out well. You probably won't.

The long-term price of Bitcoin is probably 0. Same goes for Ethereum, Litecoin, Dogecoin, and any other dressed-up pyramid scheme on the blockchain. The problem with cryptocurrency is that it isn't even any good at being currency. Yes, some people have made a fortune off of it. But there is strong evidence that big players in the market regularly engage in pump-and-dump schemes. Meaning, in a word, that the big players control the price and you have no idea when they might decide to crash it.

Winklevoss twins The Winklevoss twins want ALL your money

Investment type: Equity

How to invest in cryptocurrency: Get an account at coinbase. There are shadier options too if you want to lose your money even faster.

Best case scenario: Time your buying and selling of a niche coin perfectly. Buy a yacht.

Most likely scenario: You'll HODL until the price drops to pennies after the last crypto-bro finally passes away. RIP crypto-bros.

Chances of losing big: High

Ease of withdrawl: A few days to sell, transfer your money, and withdraw. Just know that you need to literally bribe the miners to put your transaction on the blockchain - and it'll cost you more than you think.

1.4 Multi-level-marketing

TL;DR: MLM schemes are dumb. These aren't investments.

If you've lived as long as me, by now, you've had several friends who have been lured into the MLM pit. Some sell knives. Some sell vitamins endorsed by a certain former president. Basically all of them lose money and are left with a garage full of junk that no one wants. Don't be a victim. MLM schemes are not an investment - they are psuedo-legal fraud.

Investment type: Equity (kind of)

How to invest in an MLM scheme: Don't worry, they'll find you.

Best case scenario: You're slimy enough to pull your friends (former friends) into your scheme and have made a small profit

Most likely scenario: Garage full of unsold super-sharp knives, sugar pills, and no money. What could go wrong?

Chances of losing big: Almost certain

Ease of withdrawl: I don't know... how quick can you sell those MAGA vitamins? Oh, that's right, you can't.

2. Somehow-less-stupid tier

2.1 Stuffed in your mattress

No, this isn't a serious investment strategy. But I'm including it just to emphasize how stupid the stupid-tier investments are. Let's look at the benefits of the mattress vs. the stupid-tier investments. Your money in the mattress:

  1. Will never disappear (unless you are robbed).
  2. Will never charge you bank fees.
  3. Is accessible whenever you need it.

Investment type: This isn't actually an investment

How to invest in a stuffed mattress: 🎶 Step one, cut a hole in your mattress. Step two, stick your money in your mattress. 🎶

Best case scenario: You never have to do business with a large bank again.

Most likely scenario: Your house eventually burns down along with your mattress.

Chance of losing big: How careful are you with candles?

Ease of withdrawl: Easier than savings accounts without the fees.

3. Okay tier

The four options in this tier are not outright stupid but are also probably not your best option. All of them are conservative investments that would likely meet your grandparent's approval. However, the risk/reward tradeoff is powerful and you won't make as much money with these.

3.1 Bonds

TL;DR: Bonds have a low RoR but are significantly more stable than stocks. Invest in bonds if you need to use your money in the next few years.

In order to raise funds for all sorts of things, corporations will put together a lending contract called a "bond" and sell it to people. The bond will usually be sold for either $100 or $1000. The corporations will then pay you some percentage of that called the "coupon". The coupon is the percentage of the bond price they will pay you every year - usually paid twice a year. So if the bond costs $100 and the coupon is 4%, the corporation will pay you $2 every six months. At the end of some specific number of years, the corporation will then pay back the original price of the bond. The date when the corporation pays you back is called the bond's "maturity". Sometimes bonds are also sold without coupons. In these cases, you'll pay less for the bond... maybe $85 for a $100 bond... and will get the $100 at the end of the specific number of years.

Once you buy a bond, you don't have to hold it until maturity. If you need your money back or want to invest in something else, you can sell the bond to someone else. Likewise, you can buy someone else's bond if they don't want it anymore.

The easiest way to buy and sell bonds is through your online brokerage. They usually have a section called, imaginatively, "bonds". When a corporation pays the coupon on their bond, that money shoud automatically appear in your account. Likewise, when a bond matures, the bond will disappear from your account and you'll be left with just the money.

Bonds are generally seen as low-risk compared to stocks. The only reason a corporation wouldn't pay you is if they go bankrupt and even then, you're high on the list to be paid back when the repo-man comes to auction off their stuff. Still, it's worth knowing what you are getting into. Bonds are rated kind of like eggs or children. If the corporation is very likely to pay you back, their bonds get a rating of AAA. If a corporation is iffy and a bit scummy, they get a rating of C or even a D. Bonds are independently rated by three different firms and the ratings are regularly updated.

Rating Average RoR (early 2021)
AAA 1.86%
AA 1.7%
A 1.7%
BBB 2.3%
CCC 7.2%

The lower the bond rating, the less likely the corporation is to pay you back, and the more they pay you to hold their bonds. Simple enough?

One thing to notice is the RoRs for the A-rated bonds. Remember when we said inflation is consistently about 2% per year? Well, the RoR for A-rated bonds is currently less than inflation. So when you invest in those bonds, you actually are losing money. More risky bonds are better but not by much. Either way, it's not nearly as bad as savings accounts or CDs. For comparison, the stock market has an RoR of about 8% after inflation.

Bonds vs stocks Most bonds currently have negative returns (from bridgewater)

With such low RoRs compared to stocks, why would you think about bonds at all? While stock prices can fly all over the place, bond prices tend to stay relatively steady. So one very common investment strategy is to buy both bonds and stocks. If 50% of your investments are bonds and 50% are stocks, when the stock market crashes, you have lost a much smaller amount than you would have with all stocks. Unfortunately, when the stock market booms, you will also have made less money. Use this strategy when you need your money within a few years (for example, if you are retiring). Otherwise, you should probably avoid bonds and stick with an index fund which we'll get to soon. For more on balancing between stocks and bonds, read about modern portfolio theory.

Bonds vs stocks Bonds are more stable than stocks. But, over the long-run, stocks beat bonds. For the past few years, bonds have been deeply underperforming.

If you do invest in bonds, you should invest in a couple of different companies at once. Why? Companies go backrupt all the time - and AAA bonds are not exempt. Better yet, you should just buy a bond "ETF". ETF stands for "exchange traded fund". A bond ETF is basically just an index fund for bonds. We will cover what an index fund is down below but basically, with a bond index fund, you give money to an investment company to buy a lot of different bonds on your behalf. They don't pick and chose which ones they like - they just buy them all. There are a few bond index funds that are good. In the past, I have bought AGG.

Investment type: Debt

How to invest in bonds: I would recommend just buying AGG which you can do on your online brokerage. If you actually want to buy individual bonds, your brokerage can do that too.

Best case scenario: Slightly better than inflation

Most likely scenario: Slightly worse than inflation

Chance of losing big: Low. Much lower is you use an ETF or buy a lot of bonds

Ease of withdrawl: You can buy and sell bonds like stocks. Like stocks, it's about 3 days to get your money.

3.2 US Treasuries

TL;DR: US treasuries have a very low RoR. After inflation, you lose money. However, they also have approximately zero risk. Buy treasuries if you can't handle risk at all but want to do do better than savings accounts.

US treasuries are a lot like bonds except instead of corporations, you are lending the US federal government. When this article was published, the federal government was in debt almost 28 trillion dollars. That 28 trillion is not just a number - someone has to loan them all that money - and that someone can be you!

Given the recent instability in national politics, it might surprise you to learn that the US federal government is considered an extremely safe investment. In fact, US treasuries are actually the "risk-free" benchmark. In its 240+ year history, the US has never not made a debt payment (interestingly, we have been late before). While the risk-free status of treasuries might be changing, at the end of the day, the US prints its own money. This means it won't go bankrupt by accident - only by choice.

The disadvantage of treasuries are their low RoRs. Even with 28 trillion dollars to raise, because of their low risk, enough people are buying treasuries. Just like corporate bonds, the US government likes to minimize their costs so they pay as little interest as possible.

There are three main types of US treasuries:

Type Maturity RoR (early 2021)
Treasury Bills < 1 year ~1.5%
Treasury Notes 2-10 years ~1.6%-1.9%
Treasury Bonds 30 years ~2.3%

Before we talk about the differences, look at these rates and remember we said inflation is about 2% per year. Just like AAA corporate bonds, you can expect to lose money on treasuries. Also just like corporate bonds, this is still better than losing it all to inflation via a savings account or in your mattress. In past years, you could expect to make at least small gains on treasuries but we're in a weird economy right now.

The "maturity" refers to how long it takes the government to pay you back completely. Why the different RoRs? It's because while the government is hypothetically "risk free", there is still some risk that they won't pay you back or, more realistically, inflation will go up. Since the government is asking you to trust that they will keep paying their debt in the 2050s (likely but not certain), they also have to give you a higher RoR.

Like bonds, you don't actually have to wait 30 years to get your money back. You can buy and sell treasuries at any time. If you buy a 30-year treasury that was issued in 1995, your RoR will be lower though. Less can happen in 5 years than 30 years.

Should you buy treasuries? If it's between this and a savings account, buy treasuries. If you want to actually make money with your investments, there are better options.

If you do buy treasuries, which type of treasuries should you buy? The short answer is it doesn't matter. Buy whatever length of time seems reasonable to you without looking at the rates. The few times I've bought treasuries, it's been temporary and I've bought 4-week bills.

Investment type: Debt

How to invest in US treasuries: You can buy treasuries through your online brokerage or via treasurydirect.

Best case scenario: You do slightly better than inflation in exchange for trusting the government for 30 years.

Most likely scenario: You lose some money but not much.

Chance of losing big: Low. The US congress would have to conciously decide to ruin its credit.

Ease of withdrawl: You can buy and sell treasuries like stocks. Like stocks, it's about 3 days to get your money.

3.3 Gold

TL;DR: Gold has a low RoR and is relatively stable. Invest in gold if you think shit's about to hit the fan.

Gold is weird. It has a long history spanning to the dawn of humanity. Long before we had stocks or corporations, we had gold. Up until 1971, US dollars were directly exchangeable for gold. From the stone age up until 50 years ago, gold and money were the same thing.

Since then, it hasn't had much use outside of jewelry. We can't use it to grow food, build houses or fuel cars. Most of the gold in the world sits around in big well-secured rooms. And yet, since 1971, gold has continued to increase in value. Why? Because gold is useful in unstable economic environments.

Gold basement Most gold is in rooms like this

Perhaps the most probable unstable economic environment is inflation. If money is inflating rapidly, think 1930s Germany or modern-day Venuzuela, it makes a lot of sense to hold gold. While your bank account would be quickly inflated to nothing, your gold holdings would not change. While a hyper-inflation of the US dollar is unlikely, people buy gold in response to basically any economic instability, real or imagined.

Over time, unless world gold production changes dramatically, it's likely that the price of gold will continute to go up - albeit much more slowly than stocks or bonds. We'll always have our doomsday preppers. Some of them sit underground in their backyard bunkers, others regularly shout doom from their offices in Connecticut.

Gold vs S&P500 Gold goes up but very slowly

So how do you buy gold? If you are a certain type of person, you can buy literal gold coins and hide them in your cookie jar. If you are more practical, you can invest in a gold holding company like SGOL or GLDM. These companies literally have their own basements full of gold bars like the photo above. When you buy their ETF, they go out and buy more gold bars to balance the price.

Investment type: Equity

How to invest in gold: Buy a gold ETF on your brokerage's website. My favorite is SGOL.

Best case scenario: You'll buy before a gold run starts, and sell before it ends.

Most likely scenario: You'll do a bit worse than the stock market.

Chance of losing big: Low. Like stocks, gold goes up and down. However, it's unlikely we'll ever completely replace gold (go away, cryptobros).

Ease of withdrawl: If you buy a gold ETF, as fast as any stock - about three days. If you are trying to sell your gold coins, you'll have to check with your local "We buy gold!" shop.

3.4 Mutual funds

TL;DR: Mutual funds have a good RoR / stability balance that is usually outlined in their prospectus.

A mutual fund is a set of different securities that are selected by a "fund manager". These securities can be anything but are most often stocks. When you invest in a mutual fund, the fund manager uses your money to buy their investment picks. The closest real-life example to a mutual fund is if you gave your smart cousin some money to buy stocks for you. Also assume that the cousin buys stocks for everyone in the family and you have no say in what they buy. You either give them money or you don't.

Investing in a mutual fund is usually better than you making your own individual stock picks. Fund managers are professional investors who have gotten there through a record of success. They know what they are doing better than you do.

There is another advantage to mutual funds. By investing in multiple stocks at once, you have reduced your risk. There are a number of events that can befall individual companies - from bankruptcies to product failures to being outmatched by competitors. When you own lots of stocks at once, the failure of any single company is diluted. This is a powerful counterweight to the risk/reward tradeoff.

There are a two big disadvantages to mutual funds. First, it can be difficult to withdraw your money when you need it. At best, you need to wait until the end of the day to withdraw. At worst, it might only be doable a few times a year. There can also be early-withdrawl fees. If you need your money in a pinch, mutual funds are probably not your best option.

The second disadvantage is that, historically, mutual funds have done worse than the market on average. This might seem counter-intuitive. After all, fund managers are smart people. Why are they doing worse than the market? In fact, there are good reasons for this which will be covered in the next section on index funds.

Selecting the right mutual fund often requires some research on your part. Importantly, you want to look for funds with a good RoR over a long time period. It's easy to get lucky in stocks one year and lose big the next. Additionally, different mutual funds can be designed to do different things. Some of them are given names like "aggressive growth". With these funds, you are likely to see a higher RoR over many years. In the short term though, you might lose a lot of money.

Investment type: Technically equity but may have debt components

How to invest in mutual funds: Depending on your online brokerage, you are probably able to buy some mutual funds. If your brokerage does sell funds, it might not sell every fund though. Other times, you need to invest directly through the companies themselves.

Best case scenario: You pick a fund that beats the market. If it does, it probably won't beat it by much.

Most likely scenario: Your mutual fund does a little worse than the market.

Chance of losing big: Medium-low. If you choose to invest in mutual funds, invest in different funds from different companies. Mutual funds themselves can fail for a variety of reasons.

Ease of withdrawl: Sometimes you can get your money out within a day. Other times, it might take months. There may be fees for early withdrawl.

4. Smart tier

Finally, we reach the smart tier. If you are younger than 50, all of your money should probably be going into one of these two investments.

4.1 Index funds

TL;DR: Index funds have great returns but can be unstable. Invest in index funds unless you can't stand to lose any money over the next 10 years.

S&P 500 30 years This will basically be the performance of an index fund.

Index funds are almost certainly where you should invest most or all of your money. It's incredibly easy to do and is something you don't have to actively think about.

Index funds are a lot like mutual funds. Like mutual funds, index funds are a set of different securities rolled into one. This gives you the same benefits of diversification that you get in mutual funds. If one security crashes, your entire investment will probably be fine. Also like mutual funds, the components of index funds are usually all stocks.

Index funds are called "index funds" because they track a "stock index". Two well-know example stock indicies are the "Dow Jones" and the "S&P 500". We covered stock indicies when we talked about what the stock market is. Stock indicies work by combining together the price movements of a bunch of different stocks. Hypothetically, these stock movements are representative of the entire market or a certain sector of the market. So when you invest in an index funds, the fund takes your money and buys every stock in the stock index they are tracking. In other words, with index funds, no one is actively picking your stocks. They are pre-picked depending on the index.

Let's look again at the Dow Jones industrial average. This is the stock index that combines the prices of 30 huge US companies. One investment company, "State Street", offers an index funds which track the Dow Jones called DIA. When you buy DIA, State Street buys all 30 components of the Dow on your behalf. When the Dow replaces a component, State Street will also replace the component.

The Dow Jones is useful as an easy-to-understand index. However, its been around for more than 130 years so its a little outdated. The most widely used stock index today is the S&P 500. It's basically the same idea as the Dow but instead of 30 stocks, you get 500 stocks. Being more popular amongst investors, there are more investment companies that offer index funds. The largest options are listed in the table below.

Index fund Investment company Expense ratio ETF?
FXAIX Fidelity 0.015% No
SWPPX Schwab 0.02% No
VOO Vanguard 0.03% Yes
IVV IShares 0.03% Yes
SPLG State street 0.03% Yes
SPY State Street 0.095% Yes

Every one of these index funds does the same thing. They buy all of the stocks of the S&P500. So why choose one over the other? Well, you might have noticed the expense ratio column. The expense ratio is how much the investment company takes per year for their work in buying all of those stocks. Amongst the options listed, all of the expense ratios are below 0.1% so there isn't much difference between them. Still, all other things being equal, a low expense ratio results in a higher RoR which builds over time.

You'll also notice a column called "ETF". ETF stands for "exchange traded fund". If a fund is an ETF, that means you can buy it just like any other stock. If an index fund is not an ETF, it is more like a mutual fund which might have investment minimums or early withdrawl fees. Given the minor expense ratio differences between the funds, I personally value the ability to get my money out whenever I need it.

In the table above, there are three funds, VOO, IVV, and SPLG, which have the same expense ratio and are all ETFs. Which one should you buy? The truth is, it doesn't matter. I personally hold Vanguard's option, VOO.

Why index funds are better than mutual funds

In the section on mutual funds, I briefly mentioned that mutual funds, on average, do worse than the market. In other words, no one is actually that good at picking stocks. Because this is so counterintuitive, I'll provide two pieces of evidence. The first was a few years ago. Warren Buffet, the billionaire investor, made a million dollar bet. He bet that over a ten year period, a group of hedge funds couldn't beat an S&P500 index fund. Hedge funds are basically fancy mutual funds that do fancier things with your money than regular mutual funds do. Well someone took his bet and, of course, Warren Buffet won.

To be more scientific, let's also look at a study. Over the past 10 years, Barron's found that only 22% of active funds beat the S&P500 (Active fund and mutual fund are technically different but there is a large overlap). And what about those 22%. Is it just that there are only a handful of good fund managers? Here's another example of another fund which managed to beat the S&P500 15 years in a row before losing steam.

Why would mutual funds consistently underperform index funds? It's a little complicated but its basically a combination of the efficient market hypothesis and the drag of management fees. The efficient market hypothesis is a complicated concept that is explained in the advanced section on stock picking. Management fees are basically the expense ratio of mutual funds which are much higher than index funds.

Either way, the data is clear. Mutual funds tend to underperform index funds. Unless you have a good reason to prefer mutual funds, you should always choose index funds.

Investment type: Equity

How to invest in stock indicies: If you are buying at ETF (which you should), you can buy it on your online brokerage like any other stock. VOO is a good choice.

Best case scenario: On a fantastic year, your return can be as high as 40%. This will be a one-off though.

Most likely scenario: 8% RoR yearly (after inflation). This is a doubling time of 9 years.

Chance of losing big: Low... if you can stick it out. The market goes up and the market goes down. Over 15-year time periods, the market has always gone up. Short of civilization collapse - you can expect stocks to go up indefinitely.

Ease of withdrawl: Fast. About 3 days to get your money after making a trade.

4.2 Real estate

TL;DR: Real estate is not a great investment by itself but has other advantages.

Real estate on the surface is not a great investment. Historically, it does only a little better than inflation. The average after-inflation RoR of real estate is only 1.5% for a doubling time of 47 years.

S&P500 vs home prices By itself, real estate is not a great investment.

However, the poor RoR of real estate is not the end of the story. The advantage of real estate is that you get to literally live in your investment. This allows you to avoid paying rent on an apartment and probably even live in a nicer place. Whether or not it makes sense to do this depends on a lot of factors. Generally, the longer you plan to live in a city, the more buying in it makes sense. For help, you can consult an online calculator.

After your primary residence, additional real estate can be rented out. Your rental income can certainly make real estate competitive with stocks but you'll need to be careful. Compared to stocks, being a landlord is complicated. It's often possible to make more as a landlord than with an index fund but you will also be dealing with maintenance, tenants who don't always pay rent, and individual neighborhood dynamics.

Investment type: Equity

How to invest in real estate: Call the realtor on your favorite refrigerator magnet.

Best case scenario: You'll buy in an up-and-coming neighborhood, will have only good tenants, and your investment will soar.

Most likely scenario: Assuming you rent out your property, you'll make as much as you would have made in index funds.

Chance of losing big: Low. There is only so much land on Earth and its basically all owned by someone. The more people and money in the world, the more land increases in value. There is a chance of losing money in real estate if your neighborhood or city takes a dive but this is more the exception than the rule. However, when it does happen, neighborhoods, cities, and every countries take decades to recover. Japan is still waiting... 30 years later.

Ease of withdrawl: Slow. This is an important disadvantage of real estate. It is hard to sell a house.

5. Advanced tier

If you're a beginner, I would stop reading here. There is an old proverb that "a little bit of knowledge is a dangerous thing". Picking individual stocks can be dangerous. The price of individual stocks are influenced by thousands of factors which no one completely understands but some understand better than others. To make money, you are basically making a bet that you know more than the market. And it's unlikely that the market is wrong. For amateurs, at best, you'll get lucky.

5.1 Stock picking

TL;DR: Successful stock picking comes down to knowing something that the market doesn't.

Investing in individual stocks is what happens when you forgo the ease of index funds and instead try to beat the market. If you succeed, you'll do what professional mutual fund managers struggle to do every day. In other words, it's not likely you'll succeed. At the very least, if this is an itch you need to scratch, separate out your "conservative" investments from your "gambling" investments. Your "conservative" investments would ideally be a single index fund and would make up 90% of your portfolio.

There is exactly one secret to successful stock picking - you need to know more than the market knows. The efficient market hypothesis states that all public information is reflected in stock prices. This is a simple yet deeply important concept so I'll provide an example. When a new event happens, say the release of earnings, that information spreads to every interested investor at the speed of light. Immediately, the stock price will change to reflect this new information. In other words, as an independent stock picker, carefully reading earnings reports and then buying the stock accordingly won't help you. The algo-traders and professionals have already beat you there.

Instead, if you want to beat the market, you need to have information that other people don't. This is the only way to beat the market and anyone who tells you otherwise is trying to sell you something you don't need. Now, when I say you need to know something the market doesn't know, I'm not talking about insider trading. That's illegal for good reason. Rather, I mean something far less sinister.

I'll tell you a story that might illustrate my point better - the very first stock I bought. I grew up in Colorado which happens to be where a now famous fast food restaurant was founded - Chipotle Mexican Grill. Having grown up with it, I knew how popular it was and how it was often seen as a "default" option - spiritually beating basically every other fast food restaurant. Later, I also went to college in Colorado. The students who came from the coasts had never heard of it and also immediately fell in love. Well, one day, Chipotle was about to go public. I predicted that investors were mostly concentrated on the coasts and hadn't heard of Chipotle. I also predicted that they would not buy up something they didn't know and that it would take some time for them to catch up. Boy was I right. Since it has IPOed, Chipotle beat the market 14-fold. Sadly, I only held it for 2 years as a recall.

CMG vs SP500 CMG was a good bet because I knew something that the market didn't

There are other companies you might have been able to do this with. If you know anything about the benefits of RISC vs CISC computer architectures (and I did!) you would have known that AMD would eventually do well. If you had known anything about legging fashion (and I did not!) you would have known that Lululemon would eventually do well.

Another way to find these stocks is to think about all of the companies that you know from your own job that others probably don't. If you know that a company is really good but don't think it would be obvious to professional investors, then that's a good investment opportunity.

One thing that is not worth your time is a thorough investigation of a company's financial data. For example, something like the dividend discount model sounds very promising and rigorous. But here's the problem - lots of investors already use this model. They have probaby also tweaked the model to make it work a lot better. And because of the efficient market hypothesis, the price of the stock already has all of this in place. If you use these numerical models, you aren't using any information that others don't have access to.

The last step once you have a stock is to value it appropriately. For example, without a doubt Tesla is a great company. Without a doubt, the younger generation loves it. Without a doubt, Tesla will be successful going forward. Their stock is already very expensive though. There are a few different valuation metrics including, most prominently, price/earnings and price/sales. I also publish the FFER which is a comprehensive valuation metric.

In general, the higher the number, the more expensive a stock is. As a stock picker, your task is to decide, given the information you have, whether a stock's valuation feels fair. If a stock feels cheap, and you have some information that everyone else doesn't have, that might be a good reason to bet on a stock.

Investment type: Equity

How to invest in individual stocks: Use your online brokerage... carefully.

Best case scenario: You'll find a stock that you know something about that the market does not. Then, you'll hold that stock until the market learns (which might be a while).

Most likely scenario: You'll buy some overpriced retail-driven momentum stocks and lose a lot of money.

Chance of losing big: Medium. Stocks generally go up and even bad picks will usually do okay. Still, when you are working with individual stocks, you are also working with the possibility that any one of them will go bankrupt. Be sure to diversify.

Ease of withdrawl: Easy

5.2 Technical trading

TL;DR: You won't make money doing technical trading. Don't try.

Technical trading is like stock picking with one important difference. Instead of making money betting on the success of certain companies, your money comes from other traders. Sometimes your money is their loss. More often, you are stealing tiny bits of their profit. Technical trading overlaps with day trading and algorithmic trading but doesn't have to be either.

It's possible to make a lot of money off of technical trading. It's also very unlikely that you will. I don't do technical trading nor do I think I ever will. For the same reason that numerical modeling generally doesn't work when stock picking, the dizzying world of technical analysis generally gets you nowhere. There might have been a time when any individual tactic did work but since then, the forces of the efficient market hypothesis have probably eliminated any profits you might have been able to squeak out.

Want to try technical trading anyway? Here are some more questions before you do:

Actually, scratch it all, this section, "technical trading by 99% of people", should have gone in the stupid tier. The only advanced-tier technique you should even consider is stock picking and even that is iffy.

Investment type: Equity

How to do technical trading: Watch a few YouTube videos and attend a couple of expensive conferences in dingy hotels.

Best case scenario: You can afford to hire a team of physics PhDs and make a killing on the market.

Most likely scenario: Vegas. Over the course of a few days, you'll have a couple of ups and more downs. Eventually, you'll lose your house.

Chance of losing big: High

Ease of withdrawl: Easy... if you're doing it right

Final thoughts

You should be investing your money. To do it safely, your best bet is to buy an index-fund and hold it regardless of what the market is doing. If you can't manage the risk of stocks, throw in a hearty portion of bonds - preferably a bond ETF. Real estate also has its advantages. No matter what, stay away from savings accounts and cryptobros.

Disclaimers and notes

International considerations

I wrote this for an American audience. However, what you learn here can probably be applied in your own country with modifications. Specifically, a few things are likely different including:

This article is full of simplifications. Investing is built on simple concepts but the universe goes quite deep. My goal in writing this is to educate people who don't invest at all. Therefore, I've left a lot out. If you are interested in understanding investment on a deeper level, I would suggest really digging into these concepts: