A simple behavioral economics-based guide to investing

10/15/20233 min read

This is adapted from a longer email I sent a friend who has questions about how to invest. Usual disclaimers apply (ie, don’t invest until you understand exactly what you’re doing, or find a professional who can give you advice tailored to your financial needs).

The most critical thing about investing is your mindset. It’s safest to consider investing as a vehicle for your long-term needs. By long term, I mean money that you want to live on twenty, thirty, forty, fifty years from now, but not before then. The stock market is great for saving long term because your holdings grow over time but more importantly, by holding on to stocks for decades, you're not as affected by whether the market is doing particularly well one year and terribly the next--it all averages out over the years and keeps compounding for you.

Unless you're really excited by buying and selling (and unless you have some money you don't mind losing) I'd recommend buying index funds/indexing. Indexing is when you buy all the stocks either in the stock market, an industry, or an already existing fund that tracks specific companies (for example, there's a total stock market index, a sp 500 index that buys shares across major US industries, etc). You can choose to index with a mix of international funds, emerging market funds, or even specialize by industry. With indexing, instead of buying $500 worth of Samsung's stock and then watching that money disappear as the value of Samsung stocks went down with the exploding galaxys, you'd own $500 worth of 500 or more companies. So even when Samsung phones start to explode, you're not worried about the value of your samsung stocks. Indexing generally gives better returns in the long term than playing the market. If your goal is to make money over a very long period, then indexing is the way to go.

Indexing is also a passive approach in the sense that you don't have to check on the market everyday (or every month), and you don't have to buy individual stocks. Instead you buy through a mutual fund. A mutual fund is basically a wide range of funds managed by an institution (like a bank or brokerage).You buy shares in the fund and then your money is used to buy actual stocks across the different indexes. Mutual funds are great because they do the heavy lifting and research for you. All you do is buy into a specific fund and voila, you're automatically indexing and minimizing your risk.

The one thing to watch out for if you use a mutual fund, are its fees. Most times the fees associated with a fund might look negligible--for example a 1.20% fee, but 1.20% compounded over 20 years is a lot of money and can eat into your profits even before you pay taxes on them. If you decide to go for a mutual fund, anything under 0.20% is smart.

Before spending any money, I really really recommend you start with reading If You Can by William Bernstein. Its a short, free pdf on the basics of investing but also have a treasure trove of advice that I’ll leave you to find for yourself. Then read John Bogle's Common Sense on Mutual Funds. Also, Reddit r/personalfinance is awesome—spend some time reading through the wiki which provides a much more detailed overview of the basics of investing.

I'd recommend not spending any money until you 100% know what you want out of investing--reading Bernstein's pdf and the reddit wiki will help you decide if you want to take a passive approach to investing and buy index funds or if you'd prefer a more active approach by buying individual stocks in companies directly.

Once you're certain of what direction you'd like to take, then you'll know how much ideally you need to have to start. Some index funds have a minimum amount you have to buy, others don't, but I'd say $1,000+ is a good place to start, so start saving up while you do your research (its fine if it takes months to read through the sources and decide exactly how you’d like to invest—never spend money without understand exactly what it’s going towards).

***Again: Usual disclaimers apply (ie, don’t invest until you understand exactly what you’re doing, or find a professional who can give you advice tailored to your financial needs).