Things aren’t always as they seem. Today’s Wall Street darling can quickly fade to black with a single headline. The company that everyone is talking about around the water cooler, while popular, could make for a terrible investment. Helping to fund a new neighborhood restaurant might sound like a fantastic idea, but are the fundamentals there to generate a sustainable return? Today we examine the pitfalls of investing in individual enterprises or commodities, like Bitcoin. But hey, we can still have our fun. Here’s how.
I’ll begin with a story.
The Shuttle
In late May of 2012, I’m boarding a plane from Houston to Albuquerque, New Mexico. I’m headed to the eclectic town of Taos, where I will be helping teach a geology field course for a week.
The head instructor and course organizer, one of my all-time favorite people—an irrelevant fact to this sentence—has arranged for me take a shuttle service from Albuquerque to Taos, a two-and-a-half-hour drive in normal conditions.
I exit the terminal in Albuquerque and find my way to the shuttle kiosk. Instead of a well-polished service desk, I’m greeted by a “dude” in a flannel shirt, sporting a large greasy mustache. He’s friendly and bright eyed, and I find his presence comforting compared to the punch-the-clock uniformed service back in Houston. He happily points me to the driver and a group of women assembled for the next shuttle across the lobby.
The driver, dressed in faded jeans, a Meat Puppets t-shirt, and an old pair of dirty Adidas, stands in stark contrast to the four 30-something women gathered around him. They are flowy. These ladies are wearing pants that could double as circus tents, and their “blouses” (is that still a thing?) are equally billowing. They have far too many metal bands and rings, jangling loosely around their extremities. Open-toe shoes, all of them.
They smile at me in a way that says, “you are not part of my group, but being welcoming and pleasant is an important virtue to me.”
The Drive
As we chug along north out of Albuquerque, it soon becomes clear that these ladies are headed to a retreat in Ghost Ranch, a stunning natural marvel of red rocks set against a manmade reservoir. They talk incessantly and excitedly of chakras and hums, with their right brain hemispheres on overdrive. Did someone actually say something about crystals? It’s awful. I, sitting in the back, silently stare out the window with a crooked neck, watching the arid and varied landscape pass by at approximately 65 miles per hour. The driver is also silent.
About an hour and a half into our journey, we reach the town of Española. Having traveled through this area many times as both a former student and instructor of this field course, I know that Española, despite its natural beauty, is a bit of a rough-and-tumble sort of place.
One of the women interrupts the chatter…
“You know, you guys. This place seems wonderful. My aura is telling me that this town is a special place. There is magic here.”
Out of nowhere, after not saying a word the entire time, the driver pipes up…
“Well, your aura meter must be off today. This is the heroine capital of the United States.”*
I laugh, loudly and unexpectedly.
Eight well-meaning eyeballs turn swiftly to me.
And…scene.
Perception is Only That: A Bitcoin Example
The point of this largely unrelated story is that things aren’t always as they seem, even to the well-trained shaman.
Switching gears completely, I’ve been asked a couple of times now what I think of Bitcoin. And that’s just one example. I might as well be asked what I think of Tesla, or Zoom, or copper, or any other single company or commodity that can be bought and sold.
But let’s talk a bit more about Bitcoin in particular, as it’s been so hot for the last three or so years. And it makes sense, right? In an increasingly digital world, it stands to reason that monetary transactions are also increasingly digital.
Only ten or so years ago, I was still paying cash for most of my purchases. Now I almost never use cash, preferring instead the use of travel rewards credit cards. So, it only makes sense that cards will also one day become less common (or obsolete), and a new digital currency will reign supreme. And Uncle Billy keeps telling me how I better get in now before I miss out on a good thing!
Not surprisingly, that’s exactly what was going on in 2017-2018. I started hearing friends, usually the ones with the newest iPhone on release day, humble-bragging about their new cutting-edge Bitcoin piggy bank. Hell, Union Station in Denver even installed a Bitcoin machine, whatever the hell that is. Today you can see on this website that there are hundreds of machines!
The Rise and Fall (and Rise Again?) of Bitcoin
And sure enough, for those tech-savvy folks who got in early, they were making a killing. The price of Bitcoin was growing faster than Coronavirus in Manhattan in March (I know, it’s too soon, but it’s a fantastic natural example of exponential growth). Everyone’s aura-meter was telling them that Bitcoin is a good investment!
And then it tanked. Whomp…whomp…whomp.
Let’s take a look at the period from the summer of 2017 to the fall of 2018. Over less than a year and a half, the value of Bitcoin grew and cratered in equally dramatic fashion. And how soon people forget! There are already growing whisperings of the promise of Bitcoin again. Maybe, maybe not. Do you want to bet the farm on something so volatile? I do not.
Shoe Shine Advice on Bitcoin
There’s an old urban legend surrounding Joe Kennedy (President Kennedy’s father), who made his fortune in the stock market in the early 20th century. The story goes that one day in 1929, ole’ Joe was getting his shoes shined in Manhattan when a young shoe shiner started giving him stock tips.
The experience alarmed Kennedy, who suddenly realized that hype and misinformation was being spread about the market by those who didn’t understand the fundamentals—a dangerous situation. Even the shoe shiner is giving tips! Apparently, Kennedy liquidated his assets just at the cusp at what became the Great Depression.
Whether or not this old tale is true, we know that speculation and overvaluation were direct causes of the financial meltdown not only of the Great Depression, but of the Dot-Com bubble burst and the housing market leading to the 2008 Financial Crisis.
Bottom Line: Uninformed speculation often drives unsustainable price growth, which fuels more speculation. Then—POW!—bubbles burst. Are you buying sustainable growth or unsustainable hype?
Who is Doing the Talking?
My point of all this is many folks out there get excited about get-rich-quick schemes learned from other folks who know nothing about generating real and sustainable wealth.
And sometimes it works! For a while at least.
As an example, I bought shares of Applied Materials (AMAT) back in 2011—one of my first stock-picking experiments long before the days of strict index-fund-adherence—with the following reasoning: Applied Materials makes solar panel semiconductors, among other digitally things, and I thought that green energy was the future (still do). Therefore, good opportunity for growth, right?
I bought into the company at approximately $11/share. At the time of writing, shares are priced at $58/share, and have held a more-or-less nine-year upward trajectory. Winning!
Well, what I haven’t told you about is the other five to seven companies I bought that totally bombed, my man! I ended up selling those puppies at a loss for tax-loss harvesting opportunities years ago, with my tail between my legs.
My experience is typical. About one out of eight companies I purchased have made a decent return over the span of nine years. I researched too! Every company I bought was described by some “analyst” as a promising investment. Imagine if I picked stocks based on what my coworkers or family members told me? And what about 15 years from now? Will AMAT still be chugging along? Who the hell knows!?
Bottom Line: Picking individual stocks that can sustain a reasonable long-term return is incredibly difficult. To spread risk of picking duds, the responsible investor must be well-diversified across many companies and industries, requiring a high degree of knowledge and research. Or, one can take the passive approach…
Here’s the Lesson: Pick an Index Fund
Most of us will never accurately assess the long-term viability of a single company or commodity. Perhaps no one can. However, we can expect the long-term growth of the economy as a whole. If we can’t, we’re all screwed, investor or not.
So that’s why we don’t worry (much) about all the news, metrics, or crystal-ball readers. We primarily buy one single index fund: The Vanguard Total Stock Market Index Fund (VTSAX). We put our money on the economy in its entirety. This vast collection of companies—3,486 at the time of writing—is amassed to track the investment return of the overall United States stock market. And it does an exceptionally good job at that!
We buy companies big and small through this single index fund—some who are crushing the game and some who are barely limping along. In a year, the company-make up of that fund will likely change as companies come and go or grow at different rates, but I sleep well knowing my money is diversified across the economy at large.
What do we want in an index fund?
Broad-based and diversified: Thousands of companies across multiple industries. Many of the companies are major global players, which automatically adds global diversification. Most index funds are broad-based. Just avoid terms like “growth.” Higher reward perhaps, but also higher risk.
Low Fees (Expense Ratio): Always beeline straight to the expense ratio of any fund being considered. Although expense ratios are generally less than 1% and seemingly inconsequential, a difference of a few tenths of a percent can have a DRAMATIC impact on your long-term returns. That’s an entire blog post. Here’s the skinny: pick a fund with an expense ratio no higher than 0.04%.
If you are at the whims of what is being offered (a 401(k) or other employer-sponsored program), find a fund with the lowest possible expense ratio. I can’t impress upon you how important this is for your long-term performance.
Automation. Link your bank account and start investing at least once a month. Make it automatic, and make it easy. Don’t make investing a choice that has to be made when you feel like it. Make it something that happens EVERY. SINGLE. MONTH. Always and forever. We don’t time the market.
All equities. If you want bonds, buy those in a separate index fund. There are some decent “target-date” funds that feature a sliding-scale allocation of bonds that adjust through time as you approach a traditional retirement age. We keep our bonds separate, like everything on little Tommy’s dinner plate. If you are young, at least less than 50 years old, I’d recommend going 90%+ on stocks. In the end though, do what helps you sleep at night. Bonds will soften volatility, but also grow slower than that toenail you lost from those lace-up Miuras that were a half size too tight.
But I Love Bitcoin and I Want to Play: The 5% Rule-of-Thumb
That’s fine. I realize some of you out there are not investing newbies, and you do understand some fundamentals. Or you are simply excited and want to have some fun with an emerging company. Certainly.
Our general advice is to play and experiment with only 5% or less of your net worth. Do you know your net worth? Here’s how to calculate net worth. (Shameless plug: new subscribers get our FREE tracking spreadsheet).
And hell, you might strike gold! But studies show that active investment—the type of speculation we’ve been discussing—generally underperforms a more passive approach. That’s why we want to minimize our exposure to this sort of investing. We are special snowflakes, but we’re probably not that special ;).
Bottom Line: A winning strategy is to invest passively (and regularly, each month, in ALL market conditions). Buy a low-cost and broad-based index fund, and keep buying it. If you can spare even $50 a month, you will likely be happy with the long-term results.
Summary
There’s always some company or commodity out there that gets folks excited. FOMO (fear of missing out) makes people panic. Folks buy into companies that, by the time they are popular, are likely already overvalued (or have been all along).
The recommendation here is to avoid all the news and get yourself a nice index fund. We buy VTSAX, but there are others. Find a broad-based and low-expense fund and make investing automatic and forever.
If you want to play around with individual stocks and commodities, limit your exposure to 5% of your net worth.
Try as I might, I just can’t write a short post. This post is now complete. I hope this helps!
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Thanks guys, see you next week.