Newbie’s Ultimate Guide to Stock Investing

 

This article is written for friends and family new to investing. All of whom have sadly told me they have been losing money. I wondered how this is possible in the greatest bull market in stock market history, and then I realize they don’t have access to good information. I hope this article will change that.

Here I teach you how to get started in stock investing, based on how I got started myself in 2017. It’s called index fund investing, and can be done in a regular taxable account, a 529, a 401k, or a Roth IRA. The way I do stocks, there’s zero taxes in a regular taxable account and you have more advanced options to make money faster. In the long run, a regular taxable account is the best for all situations where you never sell the stock (and therefore avoid taxes entirely). The end game will be based on borrowing money against the stocks you own, so instead of paying taxes, you get tax deductions on any interest that you pay (reverse taxes). After a certain point you’ll never pay taxes again.

[S&P 500 historical performance 1880 to today, log scale] 

Notice how smooth stocks go up after the 1940s. 100 years ago, the S&P 500 was under 10.

Investing in the entire stock market

Index fund investing is based on buying every company in the S&P 500 (all the largest companies in the U.S. stock market). This makes it safer and the growth more steady. The index contains the gains of all the major companies, so you don’t need to worry about what stock is best at any given time. You just buy and hold forever. Just set and forget. You never have to research any company in order to pick a stock. You don’t have to worry about the rise and fall of any particular corporation like some oil company that becomes out of favor in 10 years and stops growing (or MySpace, AOL, Napster). Hot new companies automatically get included into the index without you doing anything on your part.

Setting up a stock account

The best way is to use the brokerage associated with your bank. You have to go to the bank’s website to set up your new account. In many cases you have to go to your bank in person. This way it is easy to transfer money from your checking out into your stock account. There’s also peace of mind knowing that there is a big company behind your stock brokerage.

There are many instruments for S&P 500 index investing. This can be done through mutual funds or ETFs, which are traded the same way as stocks. The stock we will buy is VOO because it is the lowest fee of only 0.03% annually (which is like nothing). However much of your savings you feel like investing, just buy as many shares of VOO as possible. At the time of this writing, VOO is $405 per share, so if you have $4050 dollars then you will buy 10 shares.

The returns are 11% a year historically but 15% in recent years. The great thing about stock investing is you have access to your money at any time. You can sell all your stocks in less than a second if needed. With real estate, it’s a pain to get your money out even if the overall returns are higher.

These are my returns 2017-2021 in my cash-only account using 50% VOO, 50% stock picks like AMD, Apple, Amazon, Google, Tesla, Nvidia. The account took off after adding the stock picks to the index fund. The stock picks grew faster but also had scary ups and downs. I tripled my investment in a short amount of time. I had no idea what I was doing back then.

 

Power of compounding

Compound interest is earning interest on top of interest, so your money grows exponentially over time!

For example, if you are 20 and invest a lump sum of $20k into an index fund, and add $1000 every month, then when you are 45 it will be $1.6 million. You stop adding money and forget about it. After another 20 years, you are 65 and it’s $12.8 million. Compare this to just saving the money in a bank account which would be just $320k, a difference of $12.5 million. This assumes 11% appreciation every year, which is the average for past 100+ years. I would get bored with such conservative investing but it’s not bad!

How Taxes work for selling stocks

401k: is taxed based on ordinary income. This is the worst. In California you can pay over 60% in taxes if your income is high. Plus your money is stuck until retirement age. The 401k’s redeeming feature is the company match and some tax sheltering during your working years. But you ultimately may end up paying more in taxes for a 401k than a regular taxable account.

Roth IRA: You pay taxes first, then invest tax free. In retirement, you don’t have to pay taxes on your gains. 529 account is the same idea as Roth IRA but used only for college expenses. I personally think these are pointless if you are investing in index funds and plan to buy and hold forever anyway.

Taxable Account: Stocks sold after less than a year is taxed as ordinary income. If held longer than 1 year, then it is taxed at the capital gains rate. If your household income is under $80k you pay zero taxes. Above it you pay 15%. In California it’s about another 8% in state taxes, so 23%. But, if you’re not going to sell most of your stocks anyway, there would be no taxes to pay. The magic happens when you die and pass on your stocks, it gets inherited tax free as the tax basis resets to the value of the stocks when it get passed on. The advantage of the taxable account is it allows you to do more advanced things, instead of 15% return you get get over 50% returns. This outweighs any tax considerations.

Another useful feature you can do with stocks is to gift them to your children or grandchildren, or to your parents. If their incomes are low enough, they can liquidate the stocks right away and don't have to pay any taxes.

 

Part 2: Maintenance

Add some money every month from your paycheck or any gift money you receive. Otherwise, no need to look at your account. It will just be slow, steady growth forever. Even when the stock market goes down in a recession, you are still adding money and increasing your account. It’s similar to buying more houses as they are cheap. When the market goes back up, it will go up very quickly to make up for lost time. The trend of the S&P 500 will continue in the long run as others add in their money on top of your money.

 

Part 3: Faster growth

After a year of doing this, you may want to increase your returns. The best way to do this is wait for a stock market crash. A 10% correction happens every year. When this happens, buy a 3x leveraged ETF like UPRO. For every $1 that the S&P 500 goes up, UPRO goes up $3. Buy with both hands! You will see what happens within 2 months when the market goes back up, and you just made a lot of money really fast. You hold onto the UPRO stock forever as well. 

 

Stock Picking

You can also start adding some individual stocks of your favorite companies into your portfolio. You have to know what the company actually does, and what they plan to do in the future. For established companies, you have to look at how cheap or expensive the company’s stock is relative to the money that they bring in, and how fast they are growing. I do this by looking at the company’s PEG ratio. My blog here will talk about my own picks that I do my homework on.

As important as it is to pick good companies, the timing is also important. The best time to buy is when others are fearful due to bad news. For example, Facebook stock got beat down to only $130 in 2018 due to some data breach that happened in 2014. This has absolutely no real impact on the company in the long term, so I bought the stock. Today it is at $361. Similar situation when I picked up Tesla at $40 after news of a fatal crash by someone driving a Model X. I recently picked up some BABA stock at $180 and we will see what happens. Most people buy high at the very top when everyone else is crowding into a stock, and after a drop (expected after a big climb), they get scared and sell cheap. So two people trading the same stocks can have opposite results. People don’t suddenly sell their house if its market value goes down on Zillow, but they sell stocks for that reason because emotions get in the way of calm judgment.

 

Part 4: Common Questions

Should I start investing when market is at all time highs? and hear that it is expensive?

Yes, buy. The markets are almost always in this state. If it does go down, then there would be fear on the streets and people would be even more afraid to invest. The only historical time periods where the market was uninvestable was in 1929 and 1999 when everyone was investing on borrowed money. Once the borrowing rates increased, people had to sell, leading to more panic selling, and that crashed the market. But even if you did invest in 1999 at the peak of the dot-com bubble, you would have still 4x’d your investment today.

At the time of this writing, the stock market is fairly valued and just fine. I know this using the equation

[Expected S&P 500 P/E Ratio = -187*(10 year treasury yield) + 31]

Plugging in 1.3% for the current 10 year treasury yield, we get an expected PE Ratio of 28.5. Currently we are around a P/E of 30, so it matches pretty close. Interest rates go lower over time, so if the Fed raises interest rates, it’s unlikely to be by much. The bigger deal is that the stock market P/E ratio is more likely to go higher, not lower, and only become more expensive so might as well get in on the action during the uncontrolled rise and euphoria. If in 2029 we have a repeat of 1999 bubble, so be it. After 10x returns, a 50% drop just cuts your returns to 5x, but it’s still pretty good. Time in the market beats timing the market.

 

How do you access the money?

You need to convert your cash-only stock account into a margin account, preferably a portfolio margin account at Interactive Brokers as they are the only broker that offers low interest rates. At the time of this writing, the interest is only 1.0-1.6%. Your buying power depends on the stock, but it can be 10x with an index fund. You would not use significant margin during the end game, and instead use the margin for your living expenses. People have bought houses on margin. It doesn’t even show up in your credit report. Your money in the account has to be sufficiently large to avoid getting margin called, preferably at least $1 million but $10 million is better. If a margin call happens, you sell some stocks, or let your dividends pay off the margin over time. Alternatively, you can get a bank loan using your stocks as leverage at low interest. There’s no taxes on borrowed money, and instead you can deduct taxes on any interest that you pay. Your income may be low enough to qualify for government social services including free health care, groceries, and college.

Should I pay attention to online websites?

I occasionally check thestreet.com, CNBC, and marketwatch.com, but I don’t think they are useful. They spread a lot of FUD (fear, uncertainty, and death) and give false warnings every week that the market is about to crash. The articles are very dumbed down. There are some gems too, though. One of these is Jim Cramer's Mad Money which you can watch reruns on Youtube. Cramer gets a lot of flak because after he recommends a stock, people would buy them and the stock goes down. But long term, he's right more often than anyone else on TV.

There are also dedicated investing sites, like seekingalpha.com (I got a premium subscription) and the popular fool.com. Fool.com gives a good general overview but they are also recommending every stock on the market and many people have lost money not doing deeper research. The brokerage often gives analyst reports from reputable sources, and these are excellent. Caveat that there is a numbers analysis approach while actual stocks are driven by big ideas and public emotions about the company.

Then there is Reddit’s r/wallstreetbets forum, featuring the latest fad stocks and people attempting to pump up their stocks by getting others to invest in them. Every time I tried to give my analysis on their stocks, I get downvoted. Then people come in and respond $GME to the moon! *rocket gif* *muscle flex* and everyone gets excited in their replies. They ignore the fact that the business is heading toward bankruptcy.

 

How am I investing these days?

I don’t do index fund investing anymore, preferring to do individual stocks to grow money faster. I do use 3x leveraged ETFs (TQQQ) with TMF (3x treasury bonds) as a hedge. This is called Hedgefundie’s Excellent Adventure method. Check out my 10 Investing Rules piece for what I’ve learned over the years.

What if I live paycheck to paycheck and can only come up with small money to invest?

Find a small startup company with lots of potential. If you invested $1000 in Apple or Microsoft early on, you would have over $2 million today. On this blog I look at SAVA and ASTS, among others I will post in the future.

Should I pay down my debt first?

You should pay down any credit card debts for sure. The rest should be lower interest loans, often with options to get out of the loans (ie. student loans, massive hospital bills). My student loan interest is at 7%, but is simple interest rather than compounding interest. Furthermore, there are numerous ways to escape having to pay it. So I choose to invest making higher interest, and whatever my debt interest is, I keep the difference. 

This is called arbitrage. At the high returns I am getting these past few years, even credit card debt is not worth paying off. If you borrow money at 1% to invest in the stock market, and your return is 50%, then you keep the difference of 49%. So if you borrow $1 million with 1% interest, and with 50% return that year, you make an extra $500k. You pay the $10k interest, for a gain of $490k. Not bad when it’s all the bank’s money. Note this is the opposite of Dave Ramsey’s approach, which is geared toward a group of people who have a history of struggling with their impulsive financial choices. Here, you are taking a risk that is supported by the math, that is better to invest than pay off loans, and that the fastest way to pay off loans is to invest first. The fastest way to pay off your house’s mortgage is to buy more houses first.

 

What if I don’t have much savings to invest?

If you own any properties, or your parents are planning to gift you a property, then you can consider refinancing it to take out some equity in the house. Typically it’s a $15k fee for cash out refinancing, but you get something like $200k or much more. You can then use this money to invest in stocks or buy another investment property. It’s easy to be a millionaire in a few years if you can start out with a large chunk of money and know how to invest. See Stocks vs Real Estate article.

 

What are other good alternatives to VOO?

I like NTSX, which is 90% S&P 500 and 60% treasury bonds. When stocks go down, bonds go up, so you get a smoother ride. The drawdowns are less severe and this can improve overall performance. It’s also tax efficient unlike holding actual bonds.

Another alternative to VOO is VTI, which is total stock market. The performance is the same as VOO because the index is still dominated by the S&P 500. I consider VOO and VTI to be interchangeable.

Then there is also QQQ, which is the NASDAQ 100 index. It has outperformed VOO due to its concentration in tech companies. Big Tech companies, the FAANG stocks, been the only game in town in the past decade for outsized growth. But now, they dominate both the S&P 500 and the NASDAQ, so I expect VOO and QQQ to perform about the same from this point forward. QQQ is just the S&P 500 with slow financial and grocery companies removed.

What about having a professional invest my money?

Fund managers on Wall Street are good at preserving wealth, but not good at building it. Almost every single one of them underperform an S&P 500 index fund. During downturns, there is less drop due to their hedging practices. Their hedge practices also bleeds out the potential gains. All this is by design as their clients are retirees who wish to protect their existing wealth.

What about bitcoin and other cryptocurrencies?

Check out my article on trading Bitcoin and Ethereum.