According to Albert Einstein, things should be made as simple as possible, but no simpler. Let’s take that genius advice and boil down the rules of successful investing to their essence.
We get four key concepts. Combined as a single strategy, they can make anyone rich:
1.Inflation — Or Where Did My Money Go?
The dollar is shrinking! It’s a process so slow that you hardly feel it. But the dollar today barely buys what a nickel did in the 1950s, when a slice of pizza and a subway ride cost a dime. That’s inflation. So money looks the same, but it’s not the same. If you just save money you lose its value to inflation. Inflation demands that you invest in hard assets to grow rich. If inflation averages 2% per year you need to beat that 2% loss by a solid margin to grow rich.
2. Fear of Loss — Never Surrender to It
We are hardwired to fear loss. It’s in every creature, great and small. Take a toddler’s toy and she’ll cry. Grab a dog’s bone and he’ll bite you. When people buy stocks and the market plunges, many people panic and rush to sell in order to preserve at least some of their money. What they don’t realize is that they were just outwitted by smart buyers, picking up bargain seeds that will blossom in the next financial Spring.
Never sell into a market crash! You’ll live to regret it. The market always comes back, even if it takes a while. When there’s a fire, your loving heart says grab the kids and run. But a market crash is not a fire. It’s a fire sale. You can pick up bargains. But if you don’t have the guts to buy, just hold on tight with white knuckles — and save yourself from ruin.
3. Compounding — Einstein Strikes Again
Another statement frequently attributed to Albert Einstein is that compound interest is the eighth wonder of the world. If you understand compound interest, you earn it. If you don’t, you pay it. There’s a trick question that offers the best example of compounding, and why it defies common sense: “Which would you rather have, one million dollars or a penny doubled every day of July?” Most people would grab that million and run. But a penny doubled every day of July comes to more than ten million dollars.
No one is going to double your pennies every day for a month. But over the past fifty years, the U.S. stock market, as measured by the S&P 500, has grown an average of 10% per year. If you invested just $5 per day at that rate in a nontaxable retirement account for fifty years, you would have over two and a half million dollars. Work it out for yourself on a free, Internet compounding calculator. My favorite is Money Chimp.
4. Diversification — Your Fair Share of the Expanding Economy
So if the United States stock market has risen 10% per year for fifty years, why aren’t most investors rich? That’s easy: Most investors buy stock in individual corporations. But most corporations fail, merge or die. There were once two thousand car manufacturers in the United States. Now there are four. And most investors like to buy and sell. They think they can profit on each trade and beat the market. The TV tells them that. They usually don’t. Rapid buying and selling leads to losses: that has been known to a wise few for centuries.
Stock trading is gambling. Gambling is fun, but it’s a bad bet! Choose the best bet. The sure bet! The sure bet is to bet on the total stock market, because the stock market has been going up for decades — in fits and starts, to be sure, but up and up and up.
The great Jack Bogle of the Vanguard Group, as well as Warren Buffett — the most famous and successful investor of all time — recommend a low-cost stock market index fund tracking the S&P 500 in a nontaxable retirement account. That’s the best strategy for growing rich over a lifetime, and gets you your fair share of market gains. By the way, Warren Buffett has commended my book, Anyone Can Be Rich! A Psychiatrist Provides the Mental Tools to Build Your Wealth. His congratulatory note is on my website, and I invite you to read it.