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Investing in ETFs / index funds
An ETF is a passive fund that tracks an index (e.g. DAX, S&P 500).
If you plan to regularly invest in an ETF, such as the MSCI World, which tracks the world’s stock market, you don’t really need to know much. It is important that you invest at all.
However, there are reasons not to invest in an ETF, but rather to invest in individual stocks:
- ETF costs (even if they are low)
- All shares are bought. You may not want to own some titles (e.g. banks, armor, tobacco, alcohol, gambling)
- The well-performing stocks have a higher weighting in the index, i.e. you mainly buy the index heavyweights. In the S&P 500, the TOP6 values have a weighting of almost 50%.
- You only get the average return on the market, but you cannot underperform.
However, if you want to invest in individual shares, there are a few basic rules to consider, which I would like to introduce to you below.
Investing in stocks is always risky. Your companies can make less money, so your course will probably also fall. There may even be bankruptcies and you will suffer a total loss.
That’s why it’s important to invest in multiple stocks to spread the risk. On the other hand, you can also increase your chances of being involved in promising companies that are characterized by high growth or stable earnings.
You can lose a maximum of 100%, but there are no limits to the top. It’s simple math. Shares like Netflix, Google, Amazon, Apple or Tesla have risen by more than 10,000% since they went public. Berkshire Hathaway has grown over 1,000,000% (!) In the more than 50 years of its existence.
There is no rule of thumb as to how many companies are sufficient for diversification, but with more than 10 titles, the marginal benefit decreases significantly.
It is also best to invest in stocks from various industries in order to avoid industry risks.
Diversify across multiple asset classes
There are basically different asset classes such as stocks, bonds, raw materials, real estate / REITS (real estate stocks) or bank deposits.
By investing across different asset classes, you can reduce your overall risk.
The asset classes are in a certain relationship to each other. I have shown the correlations in the following matrix.
With a value of 1 there is a completely positive relationship. If the return on asset class X increases, so does the return on Y.
With a value of -1 there is a completely negative relationship. If the value of asset class X falls, the value of the other asset class Y increases.
With a value of 0, however, there is no connection.
For diversification, you should choose asset classes that have no (zero) or negative relationship (<1) to each other.
Know Mr. Market (psychology of market participants)
Mr. Market is a fictional person from Benjamin Graham’s investment classic “Intelligent Investor” (affiliate).
Mr. Market symbolizes a manic-depressive stock market, which regularly calls up prices for stocks. Sometimes he is extremely optimistic and demands a very high price, sometimes he is depressed and literally gives away the shares to the market participants.
Warren Buffet, Graham’s legendary investor and student, advises to watch Mr. Market closely. He illustrates this using the example of a farm. Is the yield of the farm really worth less from one day to the other just because Mr. Market has changed its asking price?
The intelligent investor uses his own mind and checks whether the farm has actually lost value. Or is the current asking price only subject to the vagaries of Mr. Market?
By investing regularly, you achieve two things:
For one thing, you are slowly getting used to fluctuations in the price of the stock market. You are no longer a bank customer who receives interest for his money. You are now a shareholder in a company and take an entrepreneurial risk. Not everyone can handle this. You have to find that out for yourself.
Andre Kostolany (he was not an investor but described himself as a speculator!) once said: “Money on the stock exchange is pain and suffering. First the pain comes, then the money.”
Rising prices are followed by falling prices are followed by rising prices … – this is the economic cycle. This relationship is shown in the following figure. It also becomes clear here that the cycles of falling prices are significantly shorter than the cycles of rising prices. A 50% slump has been followed by price increases of several hundred percent in the past hundred years.
On the other hand, you smooth out your entry-level courses through so-called cost averaging. If you buy one share at a price of € 100 and later the same share at a convenient time for € 50, then you have paid an average price of € 75.
So you reduce the risk of paying a high price with a one-time purchase. In addition, most people do not have a mountain of money that can be invested in one fell swoop.
The effect of compound interest can only be achieved through long-term investment – more on this in my contribution.
Unfortunately, quick money on the stock exchange is often promised in public. This is absolute nonsense. In my opinion, there is no shortcut to building wealth.
The opposite is the case. Companies are slowly growing through innovations and new business models. As with a child, companies have to be given the time to develop.
The grass doesn’t grow faster if you roar. You just have to give some things time. In the past 100 years, the broad stock market has decreased by 10% p.a. gained.
However, that does not mean to close your eyes. If a company develops differently than you expected, you have to admit and sell this mistake.
It is important to have a long-term strategy. For me it’s financial independence. What is it with you?
Keep an eye on the costs and fees
One of the biggest mistakes investors can make is not investing long term and buying and selling constantly.
There is a lot of truth to the somewhat hackneyed saying “back and forth makes pockets empty”. Capital gains tax is payable on each sale. You also have to pay transaction fees and exchange fees.
However, if you do not realize your price gains, you will get an automatic deferral effect. Taxes are only payable on a later sale. These are proportionately lower than if you had previously sold and got back in again.
Some mutual funds charge more fees than they give investors in price gains. My personal opinion on actively managed funds – stay away!
Invest in financial education
I now have ten years of experience on the stock exchange. Before I started investing, I first read a lot – and I still read a lot today.
When it comes to investing and also in life, I think it is absolutely necessary to be curious, to question his opinion, to admit mistakes and to constantly improve.
Many successful people have acquired enormous knowledge through regular reading. The most prominent examples are Warren Buffett and Bill Gates. Both have acquired knowledge through reading in various areas of life. Elon Musk has, as he says, acquired the knowledge of building rockets for his company SpaceX entirely from books.
So I recommend reading a lot! Two books have contributed significantly to expanding my financial horizons – I would like to briefly introduce them to you here:
Not really suitable for beginners, but definitely one of the best books on long-term investment in stocks is the classic “Intelligent Investor” by Benjamin Graham *. Warren Buffett’s teacher gives numerous tips and tricks about successful investment in this book. Buffett himself describes the book as his most important investment reading and Graham’s teachings contained therein as the basis for his own financial success. A great book, which I have read several times and keep looking up.
Another very exciting book on investment strategies is “One Up On Wall Street” by Peter Lynch *. The most successful fund manager ever gives an insight into his many years of experience. Among other things, Lynch writes about the discovery of ten excavators (stocks that increase tenfold in price), about the division of stocks developed by him according to certain categories and teaches the basics of successful value investing. A great book from an experienced investor.