Trading is the key to wealth

Today, I'd like to share with you the true secret to creating wealth, and that is trading.  Buying stocks low and selling them high at key points, getting out before it goes down.  Buying and selling constantly is the true key to creating fast wealth.

Lol, no it isn't.

I have read thousands of articles on finance, and studied dozens, if not hundreds of finance books, and many investment styles, and one thing that stands out to me is that passive investing is a far superior strategy than gambling in the stock market for the average investor.  The more I learn, the more concrete this concept becomes.  That's not to say there aren't people who don't do very well by picking stocks.  Warren Buffett has handily beat the market by about 10% annually on average over the last half century.

But for every Buffett, there are a hundred wanna-be's, people who claim to have found the perfect strategy to beat the market.  They'll dazzle you with figures, and give you a specific timeframe in which their stock picks did very well, or show you a handful of stocks they recommended back in the day that went up by a whole bunch.  Of course, what they don't mention is that they also recommended a bunch of other stocks that didn't do so hot.  Incidentally, these people are either trying to make money off you by selling you their method, or are trying to brag.

Here are a couple of examples I want to highlight.  Both were teenagers, and in both cases, the financial media pounced on their stories, making it sound like these kids were investing geniuses.  The first was a 17-year old whose name virtually guarantees he'll get "randomly selected" every time he flies.  A Stuyvesant High School student by the name of Mohammad Islam (no, really) was rumored to have made $72 million trading stocks.

Apparently trading also adds a year or twelve to your appearance 

Here's an excerpt from the original article on Business Insider: "While having caviar and apple juice with his buddies, Islam acknowledged that his net worth was in the "high eight figures."  Later that day, he was going to meet a hedge funder who "basically wants to give us $150 million."  At only 17, Islam has already rented an apartment in New York, but his parents won't let him stay there until he turns 18.  He also bought a BMW even though he doesn't have his license yet."

I snorted when I read the bit about the caviar.  Anyway, the second one was a 16 year old with a name I can't pronounce, who has made $43,000 IN 3 YEARS! (capitalization mine) by picking stocks.  The financial media loves to highlight this kind of stuff, because, much like winning the lottery for poor people, rich(er) people want to believe they can successfully gamble in the stock market and beat out everyone else.

But when you look closely, the truth comes to light.  Turns out that tubby sack of sad with the most jihad name I've ever heard (and I spied on the Taliban for several years, so I've heard a few) had made it all up.  He hadn't made a dime in the stock market, and the apartment and the BMW were all imaginary.  He was just a teenager who liked the fame as long as no one asked very hard questions.

As for the second one, yes, he did make $43k, which amazed CNN, but when you look closer, it's less  than impressive.  This kid's rich parents let him play with a quarter mil of their retirement money (that's $250,000 for you squares).  He invested in popular stocks, got lucky, and STILL underperformed a total market index fund (his annualized return was about 5.4%).  Indeed, near the bottom of the article, it says that "like other investors, Sridharan has struggled this year, admitting he got caught up in a few bad trades."  So basically he got lucky for a couple of years, but his luck ran out.

That's why you have to be wary of anyone claiming to have a special system, or who claims they can beat the market year after year.  Statistically, they're full of shit.  Trading is a zero-sum game, meaning that for one person to win, another has to lose.  So anyone can do well one year, or maybe for a couple, but over time, traders tend to revert to the mean, which means their losses neutralize their gains, giving them an average of zero.  Actually, even less than zero.  A lot of traders end up in the negative, because of all the fees they have to pay every time they trade.

So take every trading success story with a huge grain of salt.  As an average investor - and let's face it, you're extremely average - your best bet to make money is also decidedly boring.  Regular, passive investing in index funds will probably make you more money than swinging for the fences and trying to play with stocks, or with derivatives like options.  And for the love of God, don't ever borrow money to invest.  That's called leverage, and it's one of the main reasons for the 2007 housing crash.  The one exception would be if the return is guaranteed and the interest rate is lower than your guaranteed return.  That's called arbitrage, a guaranteed profit.

My investing philosophy is pretty simple.  Dollar cost average into index funds, maxing out your tax-advantaged retirement accounts first.  For the layman, that means putting the same amount of money every month into funds that mimic stock indexes like the S&P 500, which contain the 500-ish strongest and largest companies in the U.S., maxing out your 401(k) and IRA before you invest in other accounts.

Of course, I have some positions in single stocks such as Tesla - which I think will do very well over the next couple of decades - but they only represent a portion of my overall net worth.  The majority of my money is in index funds.