Chances are you’ve heard the phrase “grab the brass ring” before. It comes from the late 19th century, where carousel riders would try to grab rings hung outside the carousel, earning prizes if they grabbed a brass one; hence the phrase, now in popular lexicon as reaching for a goal.
But like any stretch, there was risk, and while the literal action involved little by way of real risk, and the downside was mostly getting an iron ring that didn’t pay a prize, many investors today encounter significant risk when reaching for the metaphoric brass ring on the carousel of investing. And where there was no harm to the carousel rider, investor lose very real money by taking unnecessary risk to reach for improbable returns.
What can we do to avoid these mistakes ourselves?
Remember that investing isn’t playing the lottery
Too many people make this mistake, trying to hit it big on stocks that look “cheap” because they trade for only a few dollars, or even less, without understanding the basics that all stock prices are not created equal.
The irony of this is striking and saddening at once. We invest countless hours and years to educate and train ourselves, and then countless more to earn a living only to risk it, usually foolishly and with little real understanding as to what we are buying, in mere minutes, sometimes. To paraphrase famed investor Peter Lynch, we will spend more time picking out a microwave oven than we will picking out a company to invest in.
If this rings a bell, it’s time to look in a mirror. I’ve been there, I can promise you.
So what’s the right way?
The secret is simplicity, patience, and consistency. Spending too much time studying every financial aspect of a company can be just as useless and unproductive as spending too little time. The first step is figuring out what you are both willing and able to commit in time and financial resources, and re-evaluate this every year.
If you’re just getting started, and you don’t make much money, that’s no excuse to put saving off. Save as much as you can: set it up so the money comes right out of your paycheck and straight to your savings or investing account. Open a Roth IRA and max it out if you can.
And even if you don’t know where to start, you don’t think you save enough to buy stocks, there are some great ETF’s out there that can treat your “small-time” money like a big-time investor’s. A couple that are worth looking at are the SPDR S&P 500 ETF Trust (NYSEMKT:SPY) and Guggenheim S&P 500 Equal Weight ETF (NYSEMKT:RPG). These are Index Funds that track the S&P 500, but they do it in different ways, which means the return is different for both:
RSP Total Return Price data by YCharts
RSP treats all 500 companies in equal percentages, where SPY weighs each company by its percentage of the index. In essence RSP means slightly more downside risk, but allows the best performers to reward investors much more fully. Between the two, I recommend RSP. Seeing as how it’s doubled the return of SPY and the S&P 500 over the past decade, I’m sure you understand why.
The key is to make regular deposits and buy shares multiple times per year. There isn’t a person or formula in existence that can regularly predict when a share price will move up or down, but what we do know is that the market has consistently produced an annualized (meaning your compound return, the real number that you can expect) rate of return of over 8% for many, many decades. And what this means is that by making consistent, regular investments over many years and reinvesting the dividends, and to paraphrase another investing legend, Warren Buffett, letting the “magic of compound interest” do the work for you, you’ll reach that brass ring without falling off the carousel.
If you’re set on stocks, there’s only one place worth starting
There are some important things to consider if you want to own shares of companies directly. First, diversify risk, which means that you need enough capital to do this, which is why ETF’s and Mutual Funds are so popular: It lets us own lots of companies without having a lot of capital. But there is a company that offers built-in diversity.
Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) is a household name, synonymous with Buffett’s legendary investing acumen. And as it has acquired and invested in dozens of powerful name brands in industries like insurance, homebuilding, transportation, and consumer goods, not to mention the stock positions in some of the most powerful companies in the world like The Coca-Cola Company (NYSE:KO) and International Business Machines Corp. (NYSE:IBM), it’s almost a mutual fund all in one stock. For many (myself included) this is the one stock I would own if I could only pick one to own.
And don’t get caught up in the usual complaint about the lack of a dividend: I would rather have Buffett and his two understudies, Todd Combs and Ted Weschler, using their proven investing acumen to re-invest Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s earnings than losing 15% to the tax man and trying to reinvest it myself. If I was a better investor than they, I wouldn’t be buying Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B). If you were a better investor, you probably wouldn’t be reading this article.
While it makes sense for most other businesses to return excess earnings to shareholders via dividends, and one day it may make sense for Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) to do so, today isn’t that day.
Foolish bottom line
Taking risky bets on things we don’t understand is a stupid way to invest, especially when the odds are against you. We have a proven way to wealth, but it takes time and patience, and above all, discipline. My recommendations won’t help you get rich quick, but they will help you get rich slowly.
What do you think? Tell me in the comments below!
The article Are You Reaching for the Brass Ring, or Hanging Over a Cliff? originally appeared on Fool.com.
Jason Hall owns shares of Berkshire Hathaway, SPDR S&P 500 ETF, and Guggenheim S&P 500 Equal Weight ETF. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Jason is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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