“How do I learn how to invest?”
I don’t get asked this often, but I do get asked often enough that I should have a resource on this topic on this blog. My recommendations are qualified as follows: first, when people ask me how to get started with investing, they usually mean public (US) equity markets, not real estate, commodities or venture capital so that is what I am responding to; second, when I think of investing in public equity, I think of the “value investing” approach, there are other ways to invest but I don’t understand them or I do not trust them so I don’t recommend them; third, I try to form a recommendation based off of what I wish someone had told me when I had this question, so it may fit a person better or worse based on their previous knowledge, experience and intelligence; fourth, I think people are usually looking for reading material when they ask this question and I think that’s the best way to learn what needs to be learned so that is what I recommend; finally, I have struggled for over ten years with DOING rather than THINKING/READING, so my strongest recommendation is to put this knowledge and the concepts learned into practice almost immediately and start learning through action as soon as you can– it’s the only way to build the confidence I mostly never had.
I think there are a few key things a person needs to get comfortable with in order to build a solid foundation as a student of investing practice. Personal discipline, inspiration and technical know-how are the required ingredients.
Personal discipline is about generating meaningful savings. Without savings, there is nothing to invest. And without a habit of saving, an investor will have difficulty weathering the inevitable setbacks in their portfolio, taking advantage of periodic market tumbles with dry powder and resisting the temptation to sell at the worst possible moment to fund a lifestyle need or unexpected emergency. To be a great investor, I am convinced, you must be a great saver. Capitalism is built on savings, so by learning how to save you are not only building a bright financial future for yourself but helping to tend to the foundation of modern society.
Inspiration is about seeing the end game, knowing what is possible and staying motivated through the hard work and daily grinding that are the meat and potatoes of actual investing work. By studying a master you can understand not only what it takes but what to expect from your own results. And having realistic expectations is important in a business where you are your own worst enemy and the most important entity to manage.
Technical know-how is about the mechanics of investment analysis. Having a rudimentary knowledge of accounting as the “language of business” so that you can intelligently read financial statements (the reports public companies issue about their operations) and understand what is going on, and understanding what great value investors look for when analyzing an investment opportunity in terms of safety and calculated return are the actual tools you need to “do investing.” But trying to get this information before you are disciplined about saving and inspired to pursue the hard work of investing is surely putting the cart before the horse.
The meta lesson here is patience! Something all great investors need to succeed.
For the dedicated student, I have five resources I strongly recommend to methodically take oneself through these concepts. Here they are in order.
Savings and personal discipline
The first book is The Richest Man in Babylon, by George Clason. The book is a collection of lessons about how to save and the benefits of saving in the form of parables of wisdom from ancient Babylon. The narrative is extremely dated and not Politically Correct but that is exactly what makes what might otherwise be a dry subject quite wondrous and entertaining to read. When you read The Richest Man your life will change if you previously haven’t been a saver or didn’t understand how to save; for those who do, it will strongly reaffirm what you do and help you connect how critical it is to your long-term investing plan.
The second book is The Millionaire Next Door: The Surprising Secrets of America’s Wealthy, by Thomas Stanley and William Danko. Millionaire is a statistical study of America’s self-made millionaires– how do they live? what are their habits? what are their families like? how do they make key financial decisions in their life? You will see the importance of savings and frugality as a common theme. But you will also learn that millionaires don’t live millionaire lifestyles by and large and they certainly don’t build their lives around competing with their neighbors on consumptive habits. Because investing is a long enterprise where small advantages accrue over time (and small mistakes and expenses snowball just as easily), a person who fully integrates their desire to live life patiently and without excess will have a much higher chance to be successful as an investor.
Okay, you’re saving money and you’re not going to let your spendthrift neighbors new car in the driveway distract you from your mission. You’re not even going to WONDER how he affords it– you know he can’t and that it doesn’t matter a wit to how you do as an investor. You’re ready to be inspired, and who better to do that job than the arch-master of modern investing, Warren Buffet? It’s time for your third learning with Buffett: The Making of an American Capitalist, by Roger Lowenstein. There is a second Buffett biography which I think is superior in a number of ways, but that is for later on. You can obsess over those details later. Lowenstein is enough right now and he still tells a good story– who was Buffett? how did he do it? what was his philosophy of investing? and what were the key episodes in his investing career that made him his billions? Reading this Buffett bio will not only make your eyes twinkle as you dream of your own pot of gold at the end of the rainbow, it will clue you in to the fact that there might be some rain along the way.
To analyze companies on the stock exchanges, you must be able to read the financial filings they make with securities regulators. In the US, these are called 10-K (annual) and 10-Q (quarterly) reports. And these reports are typically not glossy, photo-filled corporate feel good story books nor would you want them to be– they are filled with numbers, tables and charts and they’re primarily related via accounting conventions. To understand what these financial statements are saying, you should read your fourth book, The Accounting Game: Basic Accounting Fresh from the Lemonade Stand, by Darrell Mullis and Judith Orloff. The book walks you through the accounting for a simple business, a children’s lemonade stand. You won’t be ready to audit a company or step in for your CPA friend on the weekends, but you don’t need to, you just need to understand what the difference between the three major financial statements are, what revenue is and where profit comes from, how to tell if a company has a health financial picture or otherwise, etc. That’s enough and this simple and “childish” book can get you there.
You’ve learned how to save and how to focus on yourself rather than your social circle’s economic position. You’ve read about how the grand master became the grand master and gotten a rough idea of what investing is and isn’t. And you’ve gotten the basics of accounting down so you can actually understand what you’re looking at when you peer under the hood of a public company you’re considering putting your capital to work with. But how do you actually find, analyze and make investments?
Your fifth resource is The Essays of Warren Buffett: Lessons for Corporate America, by Laurence Cunningham. This is a handy resource for the collected writings of Buffett on a variety of topics related to investing and corporate value. You can learn about what makes a business well-managed or poorly managed and from there you will be a lot less dangerous to yourself when you actually try to invest in one of these companies.
However, there is a cheaper and even more rigorous way to drink at this trough. Try Warren Buffett’s Letters to Berkshire Shareholders (1977-present) available at no cost at the Berkshire Hathaway website. Berkshire is Buffett’s public holding company and the accumulated legacy of his investing activities since the early 1950s. In these letters he lays out his principles and explains the happenings in his business in enjoyable detail and with meaningful repetition. By the time you finish these 50+ years of letters you will have a better knowledge base of how to invest successfully than 95% of market participants, of that I am confident.
And you can build on it still further by hunting down the private partnership letters Buffett wrote prior to the Berkshire days (1950s-1976), by reading the Berkshire Hathaway “Owner’s Manual” and by reading the two special letters from Buffett and his partner, Charlie Munger.
If you read, re-read and understand all of that and then actually apply it, you have learned how to invest. Now all you have to do is do it!
While the recommendations above don’t represent the ten plus years I’ve devoted to studying this topic in totality, I do think they cover 80% of the conceptual ground. And it bears repeating, they cover 0% of the activity ground, to cover any of that you need to start investing, even if you don’t have 100% confidence and might make a few (small, at this point) mistakes.
For the other 20%, I have recommendations on intermediate and advanced level readings that I would not make to any but the extremely motivated or the deathly curious. And beyond those titles, I recommend nothing but a course of vigorous doing. No amount of reading can ever make up for the practical experience of attempting to find, analyze and invest in actual companies.
But some people who have asked me about this topic have, after having the above laid out for them, complained they do not have enough time. You can guess what my reaction is in that case– if you don’t have time to sharpen your axe, you are unlikely to fell any trees. And more likely, you will trip on the damn thing on the way to the forest and mash up your leg.
That being said, I realize the subject can seem intimidating the way I’ve laid it out. And I think that it’s important people get the best chance to prevent the commission of grievous errors in this domain as possible if they’re determined to act despite my apprehension. I have given some thought to a condensed list of super-accessible readings that even those short on time and discipline can get through on the way to the nirvana of being an investor.
The Quick Way To Learn About Investing
If you’re determined to jump right in to investing, there are two things you need to know:
- How to save money
- Whether you want to be a passive index fund investor, or an active value investor
I still think it’s critical to understand the importance of saving and how to do it. Without saving, there is no investing and I think a person who doesn’t understand this early on is going to suffer for it years later, especially if they are retirement-oriented.
As to the second question, it’s a personal decision determined by available time, motivation to learn and act and also expectations about returns. For people who just want to watch their savings grow faster than their bank account would permit but who otherwise don’t want to treat investing like a business or even a hobby, index investing is the way to go, all caveats aside. And if you’re going to go that route, you need to understand how to minimize your costs and (ironically) minimize your own involvement so you don’t make bad decisions about buying and selling at the worst possible time.
And if you think you want to take a more hands-on approach and really be an investor rather than just an sophisticated saver, then you need to get a quick tutorial on how an investor thinks about what he’s trying to do which you can immediately then begin applying as a framework to potential investments you find.
My quick path then has three primary readings:
- The Richest Man in Babylon, by George Clason
- The Little Book of Common Sense Investing, by John Bogle
- The 2013 Berkshire Hathaway Shareholder Letter, “Some Thoughts About Investing” section until the row of asterisks on page 21, by Warren Buffett (free PDF)
TRMIB is still my top pick for learning about saving and how to do it. The Bogle book I think is all you need to understand what index investing is, how to do it safely and whether it is right for you. You could immediately begin an index investing program after reading that book if that’s what you wanted to do.
Rather than a book, for learning the basics of value investing, fast, I recommend the essay embedded in Buffett’s 2013 shareholder letter. It is his all-time best description of the value approach and what a value investor is trying to accomplish and therefore what he looks for in an investment. If you read that and don’t get what he is saying, start your index strategy. If you do, you’re off to the races and surely will be inspired to read and do more. But the argument he lays out is robust enough to allow you to do some immediate qualitative heavy lifting if you start looking at individual companies to invest in. It’ll be pretty clear to you if they company offers an opportunity, at current prices, that jumps Buffett’s hurdle.
The Third Way
In economic history, the socialists who realized their dreams of a planned communist economy could never work switched tactics and advocated a “Third Way”, the private-public regulated market economy. Of course, it turned out to be just as nefarious as the pure communist economy in its own way and the point is there was no real Third Way available. There was only the market economy or various flavors of central-planning chaos.
People reading this who don’t want to read 5 books and don’t want to read 3 books/essays but who still want to learn about investing might be wondering, “Oh, but isn’t there a Third Way?” Actually, in this case there might be.
Recently I reviewed The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market, by Toby Carlisle. This might be the best option as far as a one-stop shop for a total neophyte goes. The book assumes you know how to save and are ready to invest. From there, it offers a simple metric (the Acquirer’s Multiple) for identifying interesting investment opportunities. It explains why the metric is an indicator of value and it walks through several historical-biographical case studies of other famous investors showing how they succeeded with an opportunity indicated by this metric. The book does a great job of explaining (by both showing and telling) why value “works”, ie, the concept of mean reversion. I think these two pieces help to inspire a new investor to feel confident and motivated about looking for their own opportunities.
The book has a bias toward action. A person new to investing could read it and then immediately run a screen of low multiple stocks and begin vetting them for an investment. And it has a helpful checklist at the end of the book to improve your overall decision-making process.
If someone insisted on one book and was clearly indicating they weren’t planning to go deep and just wanted to get busy, I think they could do a lot worse than reading this book and I am not sure they could do better because I can’t think of anything else that is simple and easy to understand (written without technicality), covers the basics of value as an approach and offers a practical tool for putting the philosophy to work.
While I think it’s really dangerous to try investing without reading or understanding anything, I also know from experience it’s dangerous to overthink it and fail to act. Following the 5, 3 or 1 item approach outlined here I think gives the interested student some basis to begin acting knowledgeably and to arrange their further experience and study into a meaningful structure for organizing thought.