Investment: Definition of business investment

 Putting money aside is good. Investing part of your savings is even better.

Letting too much money sit on your savings books is far from ideal. Especially with the meager 0.50% that your Livret A savings account earns each year...

And when you know that in comparison, the annual return of the American stock market is on average 10% (for the S&P500 before inflation), it is understandable that many people are interested in buying shares.

However, in France, we are still great lovers of real estate, which often looks less scary than the stock market. And if you're reading this article, you've probably asked yourself: should you buy stocks? Is investing in the stock market really a good idea?

In this article, I'll share with you my opinion on buying stocks, and on the best way to invest in the stock market. We'll talk about studies on the chances of winning and the risks of losing by investing, and the different ways to buy stocks.

What is a stock?

First things first: understanding what a stock is.

A stock is a small part of a company's capital. A company that wants to go public (i.e. offer its shares for sale) divides its capital into a certain number of shares. Buying a share means buying a part of the company.

So you become a shareholder and own a small part of the capital of that company. That's nice.

But apart from being able to tell people at parties that you are a Google shareholder, buying a share allows you to :

• Receive dividends if the company pays them
• Be able to sell your share whenever you want - generally, the goal is to sell it for more than you bought it and thus make a profit

For companies, putting shares on sale allows them to grow thanks to the financial contribution of their shareholders. You support the financial development of the company.

Many of us are therefore interested in the idea of buying company shares to invest our hard-earned dollars.

The problem is that asking "should you buy shares" can actually mean two things:

• Should you buy individual stocks (aka "hot stocks": e.g., buy Apple, Amazon, etc.)?
• Should you invest in the stock market, which doesn't necessarily mean buying stocks (and we'll explain why right after)?

The two questions are quite different. However, for those who are new to the stock market or have not yet taken the plunge, understanding the difference can be difficult. This is precisely what we will discuss in the rest of the article.

Should I buy individual stocks?

Buying an individual stock is simply buying one (or more) shares of a company.

That's the way most of us think about investing in the stock market: selecting stocks of companies that you think will perform well in the future, or that pay regular dividends.

Note

Dividends are a form of income paid by the company to its shareholders.

Quite simply, it is a sum of money that is taken from a company's profits or cash reserves and paid out to those who own its shares.

In practical terms, you will receive a sum of money periodically (usually quarterly or annually) based on the number of shares you own in the company in question.

Not all companies pay dividends, nor are they systematic (a company may decide not to pay any more dividends in a given period).

The dream of many who buy individual stocks is to find the next Amazon. To invest in companies with the expectation of "outsized", better-than-average returns - whether over the short or long term.

But while buying individual stocks gives many people the idea of potentially very attractive returns, the potential for catastrophic results is also there.

Why? First, because building a portfolio from individual stocks is far from an easy task. Finding the right companies to invest in is far from easy. And just because you "know" a company doesn't mean it's a sensible investment.

To give an example I've heard verbatim before, just because you rented a Tesla on vacation and thought the car was great doesn't mean buying Tesla stock is a good idea. Or even just because you think electric cars are the future.

Buying individual stocks yourself takes a lot more work than it sounds. You'll need to build your portfolio, analyze the companies you're interested in, study company reports, read financial analysts' opinions, place your stock orders at the right time, and constantly stay tuned to what's going on with the companies you invest in.

But you will also have to define your own allocation, how many stocks to buy, diversify in different sectors, company sizes, geographical regions...

Buying company shares without doing this work beforehand is more or less the same idea as playing at the casino.

But to take it a step further, even if you do all that work, there's no guarantee that you'll get those "exceptional" results you're so tempted by.

Because the second thing to know is that research or not, it's actually probably pointless to try to do better than the average market performance (i.e. " Beat the market") in the long run.

I can't do it, and it's not just because I had a BA in literature with a theater option. You probably can't either. And the same goes for pros, including those whose job is literally to manage investment funds (we'll talk about that next).

It has been shown more than once that individual investors rarely beat the market over the long term. And for many of those who do, the result is more a matter of luck than talent.

The advantages and disadvantages of buying individual stocks

The advantages

• More control over exactly what you invest in
• Fees that can be reduced, as you won't have the annual fund or ETF management fees to pay

The disadvantages

• Requires spending a lot of time analyzing and monitoring the companies you invest in
• More difficult to achieve good diversification. Studies generally recommend investing in several dozen stocks directly to start being well-diversified, which requires time and an investment that can be substantial
• Easier to get caught up in your emotions and react to the markets by buying or selling too frequently. Buying individual stocks requires discipline and a strong understanding of the markets
• More risk than investing in mutual funds or ETFs

Does this mean that investing in the stock market is a bad idea? Not at all, and we'll come back to that point right after.

What this means is that you would probably be better off investing in stocks other than buying individual stocks. And I explain how to do it a little further in the article (#suspense).

It also doesn't mean that you should never buy individual stocks. If you absolutely want to take the time to invest in certain stocks, why not, provided that these stocks do not take more than 5 or 10% of your total investment.

Let’s come to the next point: if I don’t buy shares directly, how else can I invest in the equity market?

Should we invest in the equity market?

You can invest in companies by buying individual stocks, but that's not all.

And investing in the stock market is usually even a good idea depending on your financial situation and your goals.

As I told you in the introduction, the average return on the S&P 500 (the stocks of the 500 largest U.S. companies) is 10% for inflation. A very attractive return, frankly.

Now let's look at the different ways to invest in stocks other than buying them directly. Let's move on to investment funds, and (spoiler, my favorite) ETFs.

Investment funds

Investment funds are organizations that collectively hold financial assets. To put it simply, they are companies that will collect money from individual investors and invest it in the stock market. The money you invest is put into a common pot with other investors.

You invest in the fund on your side, and the fund itself decides what and how it invests the money. Behind these actively managed funds are professional asset managers whose goal is to "beat the markets" - again, to achieve better than average returns.

Since mutual funds invest large amounts of money by collecting money from many investors, they can very easily hold many stocks (potentially hundreds). This makes it much easier to be diversified than buying individual stocks.

So it's easy to see why mutual funds are a great alternative to buying stocks directly. After all, letting professionals do the stock-picking for me can only be a good idea, right?

But as my grandfather used to say butterfly minute! It's not all that simple.

Personally, I am far from being a fan of active investment funds. I think we can do even better.

Why? Because the goal of actively managed funds is to outperform the market. And in exchange for this goal of beating the markets, they charge you fees (often substantial ones).

The problem? It has been proven that the vast majority of mutual funds fail to beat the markets over the long term.

For example, a study by SPIVA in late 2019 shows that only 29% of active funds manage to beat the market after one year. And after 10 years? That number drops to 13%. In other words, 87% of funds fail to beat the market.

As I like to say: only 13% of the funds beat the market, but 100% of the funds charge you a fee for trying. And those fees are really substantial when you invest over years or decades.

I myself have made the mistake of investing in active funds in the past without thinking twice. Because the fees are expressed as a percentage, it's hard to understand what they really mean over the long term.

Example

Let's say you invest $25,000 in an investment fund, for 25 years, with an average annual return of 7%.

In situation A, you pay 1% in annual fees.

In situation B, you pay 2% annual fees.

At the end of 25 years, you will have :

Situation A: $105,539 on your account, and paid a total of $30,147 in fees

Situation B: 81 883 $ on your account, and paid 53 803 $ in fees

This makes a difference of $23,656 between a fund with 1%es and one with 2%es.

To sum up: buying shares, a bad idea?

As you can probably guess, buying individual stocks is unfortunately rarely a winning solution. Finding the stock or stocks that will make your portfolio take off is more the exception than the rule.

And when it comes to investing your money for your life plans or retirement, do you really want to bet everything on luck? Or do you prefer results that are "average" but also historically interesting?

If you are nevertheless tempted by the "sexier" aspect of buying individual stocks, nothing prevents you from doing so (and certainly not me: my goal is not to tell you what to do).

However, you should know that it is often recommended not to have more than 10% of direct shares in your portfolio. You can, therefore "play" with a small part of your capital, and invest the rest in ETFs.

Personally, I have a few direct Apple shares that I was able to get at a discount when I was working there. And honestly, those shares have paid off well for me to this day. And yet, almost all of my stock investments are ETFs - and that's not about to change.

Attention

This article is for informational purposes only. Before making any financial decisions, consult a (real) financial advisor.

Investing carries a risk of loss.