This is Worth Reading

The fact a personal finance class is not required to graduate high school is probably the most reckless government mistake of the 21st century. Teaching people to allocate capital efficiently is literally foundation of economic growth, yet the government figures telling gas station owners to be considerate is a better strategy. So here we are, and I’ve been asked to write, in effect, investing 101. The topic is so widely covered its much more often click bait than informative. At least you know this blog isn’t click bait because there’s nothing to click on. I would like some more views though.

I’m going to do this in 3 sections. First, I want to talk about what investing is philosophically. Then there’s a Q&A format to answer some basic questions about investing. Finally, I’m going to summarize all of this by saying, “if you don’t know what you are doing, max out your 401k and then open a Vanguard account and put all of your money in VTI.”

What is Investing?

Investing is providing capital (douchey way of saying money) to an entity or entities with an agreement that the entity will provide you more money in the future. It’s both simple and very nuanced. The basic idea is that if you have money, why not give it to someone else, or some other company, who can use it to create some value for this world and in return give you more money back? In theory, this should be quite complex because every investment opportunity is unique. Does everyone with a savings account need to evaluate if the donut shop around the corner can double your money if you give them $10k to research a new Birthday Cake Celebration flavor? Luckily thousands of years of commerce and lawyers have provided us with simplified investments structures, like stocks.

Generally speaking, when you “invest”, you are investing in an “asset”. An “asset” is something that is useful or valuable. Some assets have the ability to grow in value, but have the risk of going down in value. Other assets are better at storing value, but struggle to grow quickly. As an investor, you get to choose whether you want to select something that is more stable, but grows more slowly, or something that could increase in value rapidly, but could also lose value rapidly. If you believe in the Efficient Market hypothesis, the average expected return from a group of risky assets versus a group more stable assets should be equal. So therefore, if you want to achieve average returns, all you have to do is invest in a lot of assets at random. If those assets are valued equally by a large number of independent people, you’ll achieve average returns. Average returns puts you in a way better position than the average person because the average person doesn’t invest in stocks. Hence, can we please have a personal finance class in High School???

So if you buy ~30+ random stocks, you’ll probably achieve the same returns as a hedge fund. I’m not kidding. A lot of things don’t make sense in this world.

That said, no one sleeps well at night knowing their hard earned money has just been sent to 30 random companies with the hopes it will get returned one day. I also haven’t talked about how the outcome of companies can be correlated to similar companies. If you invest in research for 30 donut shops trying to replicate the success of the Celebration Cake from Sidecar Donuts, you’ll likely have the same outcome (great success!). So go for quantity and random.

Ok, I see why you are overwhelmed. I just said buy stocks in large quantities at random. The Q&A should make this very, very simple. Plus, you’ll likely outperform Hedge Funds if you follow this advice.

Q&A – Lord Save Us All

I’m going to set up a scenario. Let’s say you work for a company that grants you stock every quarter via Restricted Stock Units. That basically means each quarter you receive a certain number of shares of your company’s stock. This is literally the same as if it you bought the stock with your own money. (unrelated, but those grants are taxed as income. Your cost basis is the price per share multiplied by the number of shares you received. So start from there).

Question: When should we pull stock out vs. when should we hold?

Answer: First, you’re paying income taxes on the stock you receive. So the stock you now own is like you just bought it with taxed income. If you sell it as soon as you receive it, your cost basis is basically the same as the amount you sold. So there are no tax implications. In terms of when should you sell, it literally doesn’t matter. The Efficient Market Hypothesis says that every stock on the stock market accurately reflects its current value. Selling one to buy another has no effect on your net worth. You may change your risk profile, but nothing changes. (This is clearly not the right forum to challenge the Efficient Market Hypothesis…please leave your scathing thoughts in the comments).

Moreover, IT’S A GOOD IDEA TO SELL ALL OF YOUR COMPANY’S STOCK WHEN IT VESTS! We’ll get into diversifying, but why would you put all of your savings in the same company that employs you? If you get laid off, how do you think your company’s stock is doing? Bad is the answer. If your company is doing well, you’ll get a raise. You should put your money literally anywhere else. Diversify!!!

Question: How do we know what to invest in?

Answer: You don’t. You’re going to place your trust in an investment vehicle (another douchey term) like an ETF. There are companies, like Vanguard, that take investors money and buy thousands of stocks in quantities that reflect the market size of those stocks. These are called index funds, exchange traded funds (ETFs), or mutual funds. Generally speaking, this is what you want to buy. There’s a litany of research that supports buying funds that invest in every stock that is public as opposed to fund managers that try and choose winners. Sounds simple? It is. Which is why it is even more important to invest in index funds that offer very low fees for investing in all of these companies. ETFs generally change anywhere between .03% – 2% / year. There’s no difference between these funds. Buy the .03% fee fund every day.

Question: When we invest in another company (not {my company}) how long should we keep it in that stock before pulling it out again?

Answer: If you’re still reading this and learning things, only sell when you need the money to buy something else. Again, there are so many studies that show trying to time the market or pick winners is a strategy that on average loses. People who do this for a living perform worse than index funds. Why bother? TBH, I bother because it’s fun for me. I like learning about a company, putting an outsized bet on that company and seeing what happens. Again, people like me are giving money to people who own index funds.

Question: What are the tax implications of selling stock

Answer: Your cost basis is the price at which you buy (or receive, you techies) a stock. If you hold that stock for less than a year (365 days), the increase in value of that stock will be taxed as income (Federal ~25%+, CA 9%+ for a total of 34%+). If you hold that stock for a year, the increase in value will be taxed at the long-term capital gains rate of 15% plus CA 9%+ for a total of 24% plus. Unless you need the money or invested in a terrible stock like SoFi or Fubo, don’t sell before a year is up. Honestly, this is such a stupid tax rule meant to benefit the rich. Hedge funds trade stock every day and pay corporate taxes. Wtf, but I digress.

Question: Are there different tax implications if you don’t pull stock out from your company for over a year?

Answer: Yes, as I said above, but you are only taxed on the increase in value from when you received the stock. If you receive $10k in stock and sell 364 days later and the stock is worth $11k, you’ll pay short-term capital gains taxes of about 34+% on $1k ($340). If you wait another day, you’ll pay long-term capital gains taxes (state and fed of ~24+%) of $240. If you don’t need the money, just wait.

Losses offset gains. So you can add up all your losses and subtract from gains, including short term capital gains. When buying and selling stock, try and do so in a way that minimizes how much taxes you pay.

Question: What’s the difference between a stock and a bond?

Answer: There’s a simple and a complex answer. The simple answer is that a stock represents ownership of a company. A bond is a loan. So you should expect to receive the interest payment until the loan is due, when you should receive the full payment. Generally speaking, people like to invest in both stocks and bonds. Ironically, bonds are much more complex than stocks because they hold a higher legal standing in terms of repayment. If you invest in bonds, just stick with a bond fund like BND from Vanguard.

Question: I know diversifying your portfolio is important – how many companies should we be investing in at once?

Answer: A lot! The best part about ETFs and Mutual Funds is they invest in lots of companies so you don’t have to. Believe me, you don’t want your entire savings riding on the fate of some cloud storage company that’s more expensive and less integrated than Google Cloud or a social media company that everyone hates, especially if you work for those companies too.

Question: What platform/website should we use to invest?

Answer: It doesn’t really matter, but I’d suggest choosing a large brokerage like Fidelity, Schwab, Vanguard, Etrade, etc. Here’s a good heuristic determining how long something will stick around: how long has it been around? New trading platforms like RobinHood haven’t been around a long time. While I don’t think they are going to lose customer funds, Vanguard is way more likely to be here in 30 years than RobinHood because they’ve proven they’ve been around since 1975. You definitely want your money to be around in 30 years.

Seriously, How Do I Invest

Ahh, time to wrap this up. I’m not going to give anyone a “how to guide.” It’s your money, you should think of this as a high school class you never took. But here’s a hint, buy index funds. Google (type in to Google) Vanguard Index funds. Learn about the fact the US economy has healthcare, technology, energy, consumer goods, etc economic sectors and just buy those. If you don’t want to make any decisions, just buy a total market index fund with a .03% fee. That’s it. You’ll retire happy and make an average return of 7% per year.

Of course there’s a lot more to portfolio strategy than just “buy index funds”. Honestly though, the more you learn, the more the research points to just buy index funds. Bonds have gone through hell the last few months, but unlike equities, there’s limited chance of recovery. So sell all of your company’s stock and buy index funds. Like go do that now. There’s a ton more nuance, but that advice alone will get you 90% of the way.