Updated: Nov 16, 2020
One of the major reasons why I wanted to start this blog is that I have many immigrant friends who keep their savings in a checking account, which pays nothing, or in a “high yield” savings account, which also pays nothing. The only investment that they are comfortable making is buying a house and they mostly use it as their primary residence. This is a suboptimal (and sometimes even risky) use of the capital, but why do we do it? Why don’t we feel comfortable investing in the capital markets?
People that I am talking about are well educated folks who are the top talent of the countries that they come from. They have highly desired jobs and receive significant compensation. So why are most of us immigrants not as savvy as when it comes to investing?
I can answer for myself. It was mostly related to the environment that I grew up in. In Turkey, investing means one of the three things; buying an apartment, buying gold or "buying dollar”. Stock market is seen as a type of gambling, for a good reason. The market is very young (opened in 1986), it is shallow, volatile and its future is unpredictable (it can permanently decline). In addition, any Turkish lira denominated investing comes with the inherent destructive power of high inflation plus significant potential depreciation of the local currency against developed market currencies (e.g. USD).
Hang with me, it is going to make sense in a second.
For example, in the last 10 years, Turkish stock market index (BIST 100) increased by ~90% which may sound like a decent return. However, in the same period, inflation increase has been a whopping 170%! Therefore, even if you were a “savvy stock market investor” who didn’t pick stocks and just bought the index fund, you would still lose half of your purchasing power because of the inflation. But it’s not over yet. On top of this, Turkish Lira depreciated almost 400% against USD in the same period (and 600% against gold prices!). That’s why most people see “buying dollar” or physical gold as the best investment options available to preserve the value of their savings.
When you grow up in such an environment, many of us prefer to keep our hard-earned dollars in a “safe” high yield savings or CD account. The problem is, not only our money is losing value against inflation while sitting at the bank (as of August 2020, “high yield” accounts are paying less than 1%) but the opportunity cost of not investing is even higher (average annual stock market returns have been 8-10% historically).
To put it into context, the purchasing power of $10,000 in a high yield savings account that pays 1% would be only $8,600 at the end of 10 years assuming a 2.5% inflation rate. On the other hand, if you invest that $10,000 into a low-cost index fund, it’s purchasing power will be $18,000 assuming the same inflation rate and average market returns.
To reach complete financial independence, you have to leverage the most powerful investment tool, which is the US stock market.
If done right, investing in stock market in the US is one of the least risky investment tools. Yes, you heard it right, and I will say it again. Investing in stocks is not risky if you do it the right way. To assess the risk of an investment tool, we need to define what risk is. As you may have learned in your corporate finance classes, the risk of assets is often measured by the level of their price volatility.
When it comes to personal investing though, your risk is a “realized” loss on your investment not how volatile its price is. Realized means locked in and final -not on paper- and it only happens when you sell the investment. There are many ways to invest in the stock market; buying individual stocks, buying group of companies in a certain industry, buying many kinds of mutual funds, ETFs, even making contracts promising to buy or sell assets in a future date (aka futures). Sounds pretty confusing right? That’s why financial advisors make money, people think it is too complicated to invest and don’t want to do something wrong. The good news is there is a way to invest right. It is not only the simplest way but also the least risky way that enables to beat the returns of almost all fancy Wall Street investors. This is also the way that Warren Buffett wants his inheritance to be invested as instructed in his will.
You invest in the stock market as a whole -not by trying to pick winners- through low-cost index funds and never sell.
When you hear people losing money in the stock market, a big majority of them make one of the two (or both) most common mistakes:
Mistake 1) They buy individual stocks that they believe are undervalued,
Mistake 2) They try to time the market, meaning that they wait until the price is “low enough” and sell when think it is overvalued.
Keep in mind that individual companies can go out of business, but the stock market stays. Individual companies’ stock prices may permanently go down and not come back up. US stock market as a whole always increases in value in the long term. Since it's inception, the average annual total return of S&P500 has been 9.8% !
It doesn’t mean that the ride will be smooth and every time you log in to your brokerage account, you will see a higher number. The market had and will have its ups and downs. But if you don’t panic during downturns and market crashes and maintain your investments (even buy more since the stock market is actually on discount during these times), you will be fully leveraging the wealth generating power of the stock market. Here are some tips from Jack Bogle, the legendary investor and the founder of the Vanguard Group: https://www.nytimes.com/2019/01/17/business/mutfund/john-bogle-vanguard-investment-advice.html
So how to do you start investing? Please read this article first, it lists every action that you need to take for reaching financial independence including investment part. Don’t forget, once you start investing the right way, ‘time in the market’ is the most important factor in growing your wealth. The earlier you start, the earlier you make work optional!