How to start investing?
The complete investor handbook - step by step
Disclaimer: As financial jargon has deterred many would-be investors for years (myself included), this investing guide has been drafted with the simplest language possible.
The complete guide to how to invest - Step by step
2. Select low-cost index funds (e.g. MSCI world )
3. Practice Dollar-Cost-Averaging (DCA).
4. Stay invested!
1. How to pick the right broker?
(i) Any form of management fees; (ii) Minimum number of monthly trades; (iii) Brokerage fees above 0.5%.
As a long term investor, you should avoid management fees at all times. While these fees may seem insignificant (e.g. 0.2% per year), don’t forget that you are going to be rich one day. As you grow richer, these fees will compound (remember how you can become a millionaire with just a 250 euro monthly investment? Well a 0.2% yearly management fee would add up to 22,328 euros). Don’t pay management fees if you can avoid it.
Regarding the minimum number of monthly trades, don’t forget that the more you trade, the more money brokers make off you. Do not be seduced by these lower pricing plans requiring you to trade more, there is a reason they offer it, and it is not in your best interest. Remember the old trader’s motto? Time in the market is better than timing the market. Simply complete your monthly, quarterly, or yearly purchase of the index fund of your choice and move on. Trading more decreases your performance over the long term.
Your broker’s commissions on each trade should be under 0.5%. The rise of online brokers has added competition to the brokerage market and commission fees are lower than ever. As a result, many brokers have found creative ways to extract money off their customers (e.g.markup fees) yet many brokers maintain their artificially high commissions hoping that their long standing customers will not shop around for a better deal elsewhere.
Other brokers will try to justify the price tag by pointing to superior customer service of financial analysis provided, avoid the marketing tricks and pick the cheapest brokers. The industry is well regulated and, should your broker somehow declare bankruptcy, the shares are easily retrievable as they are registered in your name at the stock exchange anyway.
Why 0.5%? Don’t get me wrong this number is still very high (the broker Degiro offers it at 0.04%) but I consider it an acceptable figure if you derive good value from it (e.g. linked to your main account, makes use of national initiatives that allow for tax reduction, wide selection of stock exchanges and/or ETFs).
(i) traditional banks already have a large number of customers, and they know them well. They know that a small percentage of their customers will use their brokerage services out of convenience, regardless of the price;
(ii) Most traditional banks still have legacy IT systems which are old and inefficient, and thus they must raise their prices if they are to be profitable. Don't fall for the trap.
As a rule of thumb, brokerage services are expensive at traditional banks, well-priced at online banks, and cheap at online brokers. If you can, opt for a cheap online broker.
2. How to pick the right low-cost index fund?
Step 1: Decide which indexes you want to track, here are the main ones:
- MSCI world - Which enables you to own shares in 1600 companies across 23 developed countries. This index is capitalisation weighted which means that it provides an accurate representation of the world's stock market (approximately 66% US stocks, 7% Japan, 4% UK, 3% Framce, 3% Swiss, and 15% other.
- S&P 500 - replicating the 500 largest stocks in the USA. Historically it has been the best performing index and includes today's hottest stocks (e.g. Apple, Amazon, Microsoft, or Google.)
- Eurostoxx 600 - A collection of 600 large companies from across Europe (e.g. Nestle, L' Oreal, Unilever, or Addidas)
- Nikkei or Topix - Two indexes which replicate the Japanese stock market and allows you to gain exposure to large Japanese companies (e.g. Sony, Nintendo, Panasonic, Canon, Mitsubishi, or Toyota)
- FTSE 100 - which tracks the UK stock market and enables you to hold shares in British companies such as Barclays, HSBC, or Tesco.
- CAC 40 - France's index with companies such as Louis Vuitton, Hermes, Kering, Axa, or Airbus.
- DAX - The German index with stocks such as Bayer, Allianz, BMW, SAP, or Merck.
- MSCI Emerging Markets -Which grants you exposure to the smaller and more volatile stock markets of China (41%), Taiwan (13%), South Korea (11%), India (8%), Brazil (6%), and others (21%)
Alternatively, you may try to manually replicate the world’s benchmark and allocate 64% of your portfolio to the S&P 500, 20% on the Eurostoxx 600, 8% on the Nikkei, and 8% on emerging markets.
Step 2: Once you’ve selected the indexes you are interested in, it is now time to choose the right ETF. Most likely, your broker will give you a selection of numerous ETFs all tracking the same index. It is imperative that you select the cheapest ETF out there.
Each ETF is going to charge you an annual management fee, they use this fee to pay their traders to buy or sell stocks according to how the index changes (e.g. If Amazon doubles in value, traders will need to sell some of the other stocks in the index to make room and buy more Amazon shares). This enables the ETF to fully replicate the index and ensure that you get every cent the market makes (most ETFs strive to a tracking error of less than 0.1%).
The fees are going to be different for each index. For example a well-known index such as the S&P 500 which trades in a stable currency such as the US dollar will have relatively low fees (e.g. 0.10%) while an Emerging Market ETF which need to buy stocks from numerous foreign stock markets each in different currencies may incur higher fees (e.g. 0.50%).
Shop around for the cheapest ETF provider, in Europe the cheapest are often provided by the following providers: Lyxor, SPDR, or Ishares.
(i) In most countries, an ETF distributing dividends is bound by law to withhold taxes. This means that you are likely to pay around 30% on dividends upon receipt. Choosing an accumulating ETF allows the dividends to be reinvested tax-free, thus helping you grow your portfolio at a higher pace (remember compound interests?).
(ii) Not only will you pay more taxes with a distributing ETF, but you are also going to need to invest it manually. This will take up more of your time, and will lead to lower performance as you will have to pay brokerage fees once again.
(PS: If you already have over 100,000 euros to invest, you may consider skipping brokers and ETFs all together and open an account at non-profit index fund providers such as Vanguard or Fidelity)
3. Practice Dollar-Cost-Averaging (DCA)
Don’t worry about fluctuations in stock prices; prices move up and down but always revert to the mean over the long term. Peter Lynch, one of the greatest modern investors, once said:
Far more money has been lost by investors preparing for corrections*, or trying to anticipate corrections, than has been lost in corrections themselves.
(*a correction implies a decline of 10-20% on the value of a stock or an index. A decline over 20% over a short period of time is considered a crash)
Trying to time the market does not work. It will lead you to be out of the market for a while, hence losing out on potential gains. And if you were right and the stock market does crash (which happens every decade or so), the market will recover relatively quickly and will be back to all-time-highs in a few months anyway. Remember the motto? Time in the market is better than timing the market.
I cannot stress this enough, don’t try to time to market. Ponder on the following for a moment: According to an International Monetary Fund (IMF) study of 63 countries from 1992 to 2014, the IMF recorded a total of 153 recessions, but were only able to successfully forecast 5 of them. That’s a success rate of 3.2%.
Yes you read that right, even world-class economists who devoted their life to the field, get paid over 10,000 euros per month, and have published numerous peer-reviewed research are not able to predict a recession. Let’s stop trying to predict the market and focus on earning money.
4. Stay invested
Historically, the market has averaged 9.1% yearly return, yet the average investor has averaged 4.8%. Why? Human psychology. When the market drops or crashes we tend to feel as if we must take action, we mislead ourselves that we must sell before the market crashes further, or postpone buying as we are afraid of catching a falling knife.
Unfortunately this behaviour is inherent to humans, we are born with this instinct. When we sense danger we experience a fight-or-flight moment, and this is no different in investing. Remember the covid-19 crash of March 2020? Investors panicked and sold a lot of their assets. Today most indexes are back to their pre-covid levels, and some are even pushing higher.
Bottom line: do not panic, stay invested and know that you will get satisfactory returns over the long term. Remember the example above? Despite the tech bubble burst of 2000, the financial crisis of 2008, the Eurozone debt crisis of 2012, or the coronavirus crash of 2020, a 250 euro monthly investment would have turned you into a millionaire in 40 years.
I know it can be difficult, when all hell breaks loose we feel as if we must act, but remember that deciding not to act is an action in itself.
Feel free to reach out with any questions you may have below.
As soon as possible! Ideally as soon as you built an emergency fund to cover at least two months of living expenses.
Remember, with compound interests, time is on your side so the earlier the start the richer you will get.
Open an account at a cheap online broker, buy low-cost index funds, and hold on to them foreever. If you already have hundreds of thousands to invest, you can skip brokers and open an account directly at index funds issues such as Vanguard or Fidelity.
Remember: try to avoid traditional banks and anyone who called/emailed you about an investment products, they are likely looking for an easy commission and do not have your financial interests at heart.
Ideally you should practice Dollar-Cost Averaging (DCA). Here’s how it works: you simply invest a fixed sum of money into the market each month (or every few months) no matter if the market went up or down.
Remember: Nobody can’t predict the market but the market has always gone up over the long term (by long-term we’re talking decades, not years, or months). Make your monthly purchases today and your future self will thank you.
As much as you can afford. Historically the market has doubled your money every 7.5 years, so the more you invest today, the richer you will be in the future. With compound interest your wealth should snowball to an incredible size, so don’t hesitate!
Remember: the market does not owe you anything. Just because you’ve done your homework and picked the best way to invest (index funds) does not mean that you will get rich quick. Sometimes , as in the early 2000s, the stock market remains low for several years, other times it gains 40% in just a few months (e.g. 2020). You can’t predict the market and you never want to be in a position where you have to sell stocks at a loss simply to survive, make sure you have enough cash to cover basic necessities for a few months. If you anticipate a large purchase (e.g. car or home), set aside some cash in bonds so that you can cover the downpayment. After that, feel free to invest the rest!
This depends on the type of investor you are, but if you ever want to be rich, you should invest in the stock market. The simplest way to do so is to buy into an index fund (e.g. the MSCI world which tracks the world’s stock markets). Index funds will guarantee that you match the stock market’s gains and ensure you never lose all your money by picking the wrong stock at the wrong time. Buy an index fund, hold it for decades, and watch your wealth snowball.
Alternatively, if you’re feeling confident and are well versed in fundamental analysis, you can try to luck by buying shares in individual companies. You can then adopt various strategies and become a dividend investor for example. You may not get as rich as you could with index funds, but some people appreciate the peace of mind gained from small but stable passive income.
Never. Ideally you should only sell stocks when you attained your financial goals. You would then follow the 4% rule.
The 4% rule is a time-tested strategy. Under a portfolio allocation of 60% stocks and 40% bonds, investors who withdraw 4% of their portfolio every year will never run out of money.
Once your portfolio is large enough you will never need to work or invest in it ever again. How do you know if your investment portfolio is big enough? Simply multiply your annual expenses by 25 and that is the number you should work towards.