Investing

Former Vanguard CEO: 'If readers of my book come away with one thing,' I hope it's this money lesson

"There is little evidence anyone has ever traded themselves to wealth."

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It's easy to see why new investors are jumping into the stock market in droves: Rock-bottom fees and commissions and slick brokerage mobile apps have made it cheaper and easier to get into the market than ever before.

These developments are often good for newer or more casual investors, but experts say that a breezy trading experience — one that often entices users to trade with rewards and peppy animations — has come with the unexpected side effect of blurring of the lines between investing and gambling.

Calls to gambling helplines from frustrated traders have shot up since the pandemic began, according to a report from the Financial Times, leading investing experts to warn novices against the allure of using the market to try to hit the jackpot.

"American corporations have turned out to be a wonderful place for people to put their money and save, but they also make terrific gambling chips," said none other than Warren Buffett at his most recent annual shareholder meeting. "If you cater to those gambling chips when people have money in their pocket for the first time and you tell them they can make 30 or 40 or 50 trades a day and you're not charging them any commission but you're selling their order flow or whatever .... I hope we don't have more of it."

To avoid getting sucked in, investing pros recommend instituting a portfolio strategy that insulates the bulk of your money from the temptation to invest for quick profits. "Separate your serious money from your play money," Jack Brennan, former CEO of Vanguard and author of "More Straight Talk on Investing," recently told Grow. "If readers of my book come away with one thing, it should be that."

Understanding the difference between investing and gambling

For new investors, investing and gambling in the stock market, also known as speculating, can seem like the same thing. You choose where you want to put your money, and those picks go up or down resulting in a profit or a loss. Smart picks can make you rich; losing picks can cost you.

Between the slow-and-steady strategies of investing and the immediate gratification of profiting off of trades, it's easy to see why some investors choose to roll the dice, says Dan Hawley, a certified financial planner and president of Hawley Advisors Wealth Planning in Walnut Creek, California. "When people think they can get their hands on money quickly in the market, lights are flashing and bells are ringing," he says.

In other words, he says, "day trading is exciting. It stimulates the brain. Real investing is like watching paint dry."

Investors would be wise to understand that buying and selling investments in the hopes of turning a quick profit, and holding a diversified portfolio meant to appreciate over the long term, are vastly different propositions, says David Bize, a CFP with First Allied in Oklahoma City, Oklahoma. "With gambling, money is transferring from losers to winners, so it is almost a zero-sum game," he says.

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Essentially, every time you make a short-term trade, you're either on the winning or losing side of it. And before you begin to think that you can buck the trend and beat the proverbial house over the long term, remember that study after study of investors the world over has shown that most day traders lose money.

Conversely, because the economy has trended up over time, and corporate earnings along with it, investors who are sufficiently diversified are in a better position to earn long-term returns in the stock market, Bize says.

3 tips for investing responsibly

None of that is to say that financial experts would tell you never to invest in individual stocks or cryptocurrencies, or even refrain from using some cash to splash around in the market. Most would simply urge you to be responsible. Here are three tips to keep yourself on track.

1. Build a diversified core portfolio

Trading in and out of positions pays off for some investors, but it's not the way that most people successfully build wealth, says Brennan. "There is little evidence anyone has ever traded themselves to wealth," he says. "Keep your serious money separate. No one is going to tempt you to make speculative trades inside your 401(k) plan."

You'd be wise to invest money you have earmarked for long-term goals among a broadly diversified portfolio of low-cost investments, experts generally say. By spreading your bets across a variety of investments, you reduce the chances that a large decline in any single position drags down the overall performance of your portfolio.

Diversifying also smooths your returns, making it less likely that you'll panic and sell your investments in the event of a large drawdown in the stock market.

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2. Create a second account for your 'play money'

If you do feel powerfully about the potential for a single investment, it's OK to make a targeted bet in the hopes of earning a big return. But as is the case in a casino or when buying lottery tickets, you'd be wise to avoid putting down more than you can afford to lose.

To visualize what amount of money might be appropriate, think of your overall financial picture as a pyramid, says Hawley. Things that stabilize your life, such as your emergency fund and your insurance policies, belong at the foundation, he says. "No one will care about your portfolio if you lose your job and have to sell your house because you can't afford the mortgage payments," he says. "A lot of people want to invert the pyramid, but speculation belongs at the very top."

If you can afford to, divert some of your money into a "play" account that can keep you entertained while the rest of your money does the boring work of growing, says Howard Dvorkin, a certified public accountant and chairman of Debt.com. "Once you put the bulk of your portfolio into diversified funds, you can take a small percentage of your money to play around with individual names."

3. Choose investments with purpose

Even within that "play" account, pick investments because you think they're headed up. "Not all investments are speculative bets," says Elizabeth Evans, a CFP and managing partner at Evans May Wealth in Carmel, Indiana. "Young investors need to look at any investment as a shareholder. You're a partial owner of that business."

Before picking an investment, she suggests, examine the underlying fundamentals. "We believe we're buying the best companies in the U.S. and around the world," she says. "That's because we're looking at companies with strong balance sheets and that we believe can grow into their earnings."

If you don't have time to do extensive research on an investment, you're essentially throwing darts at the wall, says Dvorkin. "It's hard for me to believe a person that is not an investment professional, and who is concentrating on an entirely different career, has the time to put in the appropriate research to come out ahead of the pros," he says. "Mutual fund companies have 40 analysts who have gone out, done their research, been to company headquarters, and have met with the CEO."

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