ChrisHibbert comments on Procedural Knowledge Gaps - Less Wrong

126 Post author: Alicorn 08 February 2011 03:17AM

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Comment author: Vaniver 09 February 2011 07:00:52PM *  22 points [-]

How to Buy Stocks

First Option:

  1. Acquire at least $3,000 in a checking account, and grab your account number and routing number. (It's written on the bottom of your checks.)
  2. Go to Vanguard.com and open an account.
  3. Buy into VTSMX, the total market index fund, or VFINX, the S&P 500 index fund. If you have trouble picking, flip a coin; they're very similar funds.

Second Option:

  1. Go to Sharebuilder.com and open an account. They shouldn't require a significant starting balance, but might.
  2. Sign up for automatic investing to take advantage of dollar cost averaging.
  3. Buy VFINX or VTSMX.

Third option:

  1. List out what you know about a company.
  2. List out what the market knows about that company.
  3. If your knowledge is better than the market's, then proceed. Otherwise (including if you don't know how much the market knows), go to option 1.
  4. Go to your bank and read about their brokerage accounts. If the fees aren't excessive (check Sharebuilder and other banks and stuff like etrade), open a brokerage account, or go to option 2 and open a Sharebuilder account.
  5. Transfer money to your brokerage account.
  6. Plan out your trades: under what conditions will you buy a stock? (not "the price now is ok" but "if it's less than $60 I think it's worthwhile.") Under what conditions will you sell a stock? This is mostly a restatement of steps 1 and 2, but it's nice to have these numbers for every individual stock.
  7. Execute trades; the interface should be straightforward.

The last option is very rarely a good idea. You cannot pick good stocks- good stocks do not exist. What exists are good companies and good opportunities. Companies that everyone knows are good- like Apple- are rarely good opportunities, but sometimes the company is so good that it's worth buying at a premium. I'm up 9x on Netflix over 4 years, even though I bought it at a fairly high price, because I recognized that it was going to reshape its industry and eat Blockbuster's lunch. I'm up 50% on BP because I was able to identify the point of maximum pessimism and buy then. That's 2 significant winners over the last 4-5 years of active investing. I'm in the black overall only because of how awesome Netflix was; there's a lot of stocks I bought that lost a bunch or merely tread water. I now take the opportunity approach seriously.

The moral of the story is that you should hunt opportunities where you have something the market lacks, and then bet big on those opportunities. If you don't have any more knowledge than the market, bet on the market as a whole in an index fund. I had more foresight than the market as a whole when it came to Netflix (but not to many other things I bought) and a sterner stomach than the market when it came to BP, but without that edge I'm not comfortable betting on anything but that the general trend of the market is up.

(You can still lose when you've got an edge- one of my friends called the tech bubble and shorted the market, but was early by a few months and lost quite a bit of money- but it's the best and most consistent way to win.)

Comment author: ChrisHibbert 13 February 2011 07:56:08PM 1 point [-]

I've been investing in stocks (occasionally) and mutual funds (consistently) for about thirty years, and I endorse Vaniver's advice heartily. I think overall, I'm up on stocks, due to doing most of my stock investing in cyclical stocks that I can buy and sell repeatedly over the course of many years. This has worked for me with both SGI and Cypress, which I repeatedly bought at low prices and sold at high prices. If you try this and find that you're not buying low and selling high, then you should stick to mutual funds and a buy-and-hold strategy. I've dabbled in other stocks where I thought I knew something and could time it, but few of those have turned out well. Happily, I knew I was dabbling, and kept the amounts low, so I got a valuable less for a relatively low price.

Mostly, I invest in mutual funds. I have subscribed to a newsletter that specializes in rating No Load funds (there are a couple). This gives me a monthly opportunity to review the performance of the funds I'm invested in, so I can tell when they stop being in the top performers and roll my money over to a different investment.

I record the monthly performance of each of my investments in a spreadsheet (used to be a paper notebook). The newsletter tells me which quintile the performance is in compared to the fund's peers. I highlight 1st and 2nd quintile in green, and 5th quintile in red. When the number of reds gets to be high compared to the greens, I look for a different fund with better recent performance. The commercials always say "past performance is no guarantee of future returns", but it's the only indication you can use. Most of the time performance is consistent over periods of a few years, so you have to look back a year or so when evaluating, and monitor continuing performance in a consistent way.

This whole process takes far more attention than most people are willing to put into it (a few hours a month on an on-going basis, and several hours every six months or so when choosing new investents), and few investors do even as well as the rate of growth of the broad market. That's why investing in the S&P 500 or an even broader market index is a good idea. If you put your money in a broad index and let it sit, you'll do better than 3/4 of investors.

Vanguard is only one decent brokerage. I personally use Schwab, but there are several others with reasonable prices.

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