# Investing 101 Wealth can provide safety, security, flexibility, peace of mind, and opportunity. I'm assuming you do not currently feel like you have enough wealth for your goals yet, in which case you probably would like to grow your wealth. Investment is a useful tool for doing that. ## Table of Contents [toc] ## Types of Wealth Wealth can be divided into 2 categories: 1. Money. Like what's in your checking or savings accounts at your bank. You want to have enough money here to cover your short term living expenses and emergency funds. However, if you have extra money you don't need, there are better things you can be doing with it than leave it sitting in your bank. 2. Assets. Anything else you own of significant value, including a house or stocks. Ideally, your assets should grow and become the majority of your net worth. There's also credit cards (which are debt, not wealth) and retirement accounts (which are deferred wealth). More on these below. ## Growing Your Wealth If you do not grow your wealth, then it will atrophy. Inflation reduces the buying power of your wealth over time. Other people are trying to grow their wealth too, and if we do not keep up, their wealth will dilute our wealth in the total pool of wealth that people use to buy things and they will out-buy you. Ways you can grow your wealth include: 1. Having gainful employment. 2. Minimizing spending. 3. Minimizing taxes owed on income. I won't get into the politics of what tax law ought to be for the good of society, but you will likely want to minimize how much you personally owe, or else you could fall behind other people who minimize their taxes. 4. Investing your wealth in places where it will grow on its own. 1. Bonds and CD accounts are low risk ways to do that. 2. The stock market is risker, but has historically been the most effective place to grow wealth over the long term. It shrinks in some years, but over the past 10 years, the overall stock market has grown by 2.8x! Well, actually more like 2.1x after accounting for inflation but that's still nice. Imagine your wealth doubling every 10 years! Unfortunately, it takes money to make money, so poorer people can't benefit as much from investment, but rich people rely heavily on investment for growing their wealth. Regarding the risks, I'll mention that the coming federal administration may be cause for alarm, but my cynicism leads me to suspect that their policies will favor richer people and the tools that rich people use to manage their wealth. So use rich people's tools! The sooner you can invest, and the more money you can invest, the more effective it will be for you. ## The Stock Market The stock market is weird. It's basically gambling on popular sentiment about corporations. I don't like it and I'm not even convinced it ought to be legal. But it is legal and people are relying on it to grow their wealth and if we don't participate then we could fall behind other people who do. I guess the advantage that it has over gambling is that "the house" doesn't "always win" and it is possible to make money over time. Stocks kinda represent shares of a company's value in the event that it is purchased or goes bankrupt and gets liquidated. This is relevant for smaller startup companies where you can get a cut of the sale. For larger companies, like Microsoft, I don't think many people anticipate that the company will actually disappear in the foreseeable future, so as far as I can tell the value of these stocks is simply that other people are willing to buy them from you (because they think that they'll be able to sell them yet again later). I mean, the value of money has always been that other people believe it has value, so I guess that's normal, except that stocks are more volatile than money. Whenever a news story comes out about a company or industry, the perceived value of the stocks can change, and thus the market value changes. ## Managing Risk The market volatility of stocks is bad, but you can reduce the risk by investing in multiple different stocks in different areas, so that if one company's stock value plummets, it'll only affect a fraction of your investment portfolio. This is called diversifying, and the financial industry has developed powerful tools for diversifying called ETFs ("exchange traded funds"). An ETF is a thing you can purchase shares of on the stock market that are automatically reinvested in multiple companies on your behalf, so it's an easy way to indirectly invest in multiple companies. Modern ETFs are very efficient and cheap to run and have miniscule fees, so you benefit from nearly 100% of the indirect investments. I spoke with a financial planner, who recommended an ETF called "Vanguard Total Stock Market Index Fund", which is traded under the code "VTI" on any popular trading platform, including Vanguard itself but also on e.g. Schwab, Morgan Stanley, or E*Trade. VTI basically represents the entire US stock market, so if the stock market is doing well, then VTI is doing well, and vice versa, making it the least risky thing possible in the stock market. There is a downside to reducing risk: the potential for growth will likely be reduced as well. Growth and volatility tend to be correlated. It is up to you to decide what degree of risk you're comfortable with. ## ETF Comparisons Here are some ETFs with various risk/growth tradeoffs that you may find interesting: * [VTI, "Vanguard Total Stock Market Index Fund"](https://www.google.com/finance/quote/VTI:NYSEARCA): Represents the entire stock market. Lowest risk. * [VOO, "Vanguard S&P 500"](https://www.google.com/finance/quote/VOO:NYSEARCA): Represents the 500 largest companies. Historically performs very similarly to VTI, with maybe a little more long term growth. * [VOOG, "Vanguard S&P 500 Growth Index Fund"](https://www.google.com/finance/quote/VOOG:NYSEARCA): Represents a subset of the 500 largest companies expected to grow the most. Grows slightly faster during market upswings, shrinks slightly faster during downturns. * [VGT, "Vanguard Information Technology Index Fund"](https://www.google.com/finance/quote/VGT:NYSEARCA): Represents big tech companies. Higher growth and volatility (but not as high as investing in individual companies). Overall the tech industry has been doing well lately and is expected to continue growing (because powerful companies seek to consolidate power into themselves). Then again, maybe the AI bubble will pop soon. [Here's a chart comparing the performance of the above ETFs to each other and to Google stock alone over the past 5 years.](https://www.google.com/finance/quote/GOOG:NASDAQ?comparison=NYSEARCA%3AVTI%2CNYSEARCA%3AVOO%2CNYSEARCA%3AVOOG%2CNYSEARCA%3AVGT&window=5Y) Note how, at this timescale, the higher risk investments clearly tend to grow faster than the lower risk investments, but during the 2022 downturn they also shrunk faster! You can shorten the timescale, in which case it becomes less clear what the overall growth trends are and more clear that the higher risk investments fluctuate in value a lot. During a 2 month period between July and September of 2024, Google stock lost 22% of its value! But then it recovered all of that value again over the next 3 months! Because, as the internet likes to say, [stonks](https://www.google.com/search?q=stonks&udm=2). It's also possible to pay a human to manage your investment portfolio for you, but the fees are higher than using ETFs and it is very difficult for a human to reliably predict the best investments to make. According to the [efficient-market hypothesis](https://en.wikipedia.org/wiki/Efficient-market_hypothesis) (which apparently is not accurate but pragmatically speaking might as well be accurate) our best predictions about the future value of stocks are already factored into the current market price that people are willing to pay for them, and trying to do better is nearly pointless. When evaluating a company's stock, the question you should be asking yourself isn't "Is this company doing well?" but rather "Will this company do even better in the future than it's doing now in a way that other investors didn't anticipate and factor into the current market value?" and your answer is probably either "I have no idea" or "I have insider information about the company's prospects and therefore it is [illegal](https://en.wikipedia.org/wiki/Insider_trading) for me to trade its stocks right now". It would be very dangerous to overestimate our prediction skills when our life savings are on the line, and human cognitive biases are not well suited to the stock market! ## This section is for Google employees. Anyway, if I've convinced you to diversify your investment portfolio by investing in ETFs, you may be wondering what to do about the Google stock that you receive as compensation for employment. If you're not comfortable with the level of risk from having all your investments in one company stock, you may prefer to reinvest some or all of it into ETFs instead. In that case, you'll have to sell off the Google stock so that you can use that money to buy ETFs, but be careful because there are tax consequences for doing so, see below! Also, keep in mind that Google employees (and possibly their family) are prohibited from trading Google stock during the first month of each quarter of the year leading up to its quarterly earnings reports, as a way to mitigate chances of insider trading. ## Taxes on Assets You have to pay taxes on income. Income is any transaction that increases your wealth. The rules for calculating how much tax you owe are complicated, but basically every time your total wealth increases, a percentage of that increase will be taxed. That includes assets, but assets do not grow on their own as far as the IRS is concerned. The IRS considers the value of an asset to be its sale price at the time that you obtained it. (This price is called the "cost basis".) So if you paid for the asset with your own money, you're merely trading one form of wealth (money) for a different form of wealth (asset) with the same value, thus your total wealth stays the same and there is no tax impact. On the other hand, if you're given an asset as an employment benefit, that's income and you have to pay taxes on its current market value. (FYI the Google stock we receive is the remainder after taxes are already accounted for.) If you hold an asset for a while, its market value may have changed, meaning someone may be willing to buy it from you at a different price. The IRS does not care about this subjective change in valuation until a sale actually occurs, at which point the new sale price determines the new value of the asset. If you sell an asset for more than it was worth when you obtained it, that's a "capital gain", and if you sell it for less, that's a "capital loss". You owe taxes on capital gains, because they increase your wealth, but capital losses are also important to consider because you can deduct them from your income when you file your taxes. Capital losses are kinda like negative income for tax purposes, and can be used to cancel out some income from gains so that you owe less tax. Too bad regular money doesn't work like this so I could deduct the money I used to buy a sandwich as negative income. (But charitable donations and business expenses do kinda work like this in that you can count them as deductions!) There's [special federal tax brackets for assets that you sold more than a year after acquiring them](https://www.irs.gov/taxtopics/tc409). These "long term capital gains tax rates" are significantly lower than other federal income tax rates, so if you have stocks that have grown in market value, you should strongly consider waiting until at least a year after you bought them to sell them again. Note that, to determine which long term capital gains tax bracket you're in, you need to add your regular income, e.g. if I have $X regular income and $Y long term capital gains, my long term capital gains are taxed at the bracket that (X+Y) falls into. Also note that for state taxes you may need to pay the regular rates even for long term capital gains. ## Strategies for Trading Stocks or ETFs Many people say you should "buy low, sell high", meaning you should aim to buy stocks when they're cheaper, and sell them when they're more valuable, in order to make a profit. That's certainly what you want to happen, but I don't think it's very actionable advice because, as I said, it's difficult to do better than the market at predicting whether the price will be higher or lower in the near future than it is now. It's probably not worth your time to be monitoring stock prices, let the professional day traders worry about profiting off of the random price fluctuations. I guess my best advice on this strategy is to wait for a news story to affect a company's stock price, then wait a day or so to see where the price settles, then if you think the price will rebound from there later on after the news story blows over you can make trades based on this assumption. You should only be making trades that you already wanted to make anyway, but maybe if you're lucky you can time the trade in a way that is most advantageous to you. A more important strategy is to buy assets that you expect to have the right balance of stability and long term growth for you, and just hold on to them as long as you can, and try not to get spooked by momentary drops or market downturns. You should try to keep as much of your money invested in something as long as possible, because there are tax consequences for selling. You'll probably have to pay these taxes on your capital gains eventually anyway, but there are several advantages to waiting and minimizing how often your assets get traded: 1. Long term (>1yr) capital gains are taxed more favorably than short term gains. 2. If you wait until retirement, then you'll have less regular income, so your capital gains will fall into a more favorable tax bracket. 3. If you're still holding assets when you die, the cost basis gets reset to the current market value and your heirs won't have to pay any taxes on the capital gains that accrued during your lifetime! 4. There's also a mathematical reason that taxes can get compounded that I don't see discussed very often. Say you receive N dollars, and after paying taxes you're left with a portion X of the original value, so you have N\*X dollars. You invest all of this into a stock, and wait until it doubles in value to N\*X + N\*X, and then sell it, at which point you pay taxes on the gains, leaving you with N\*X + N\*X\*X. See that X²? Every time you make a trade with gains, the taxes eat another fraction of your gains! (This is where retirement accounts like a 401k help, see below.) However, in spite of the above points, you may decide that the time has come to change what you're invested in. For example, you may want to invest in a house, or in an ETF that you think is a better fit than whatever you're currently invested in. In that case, it's time to sell some assets. You might not want to sell off all of your investment at once, depending on your tax brackets. Figure out your total expected income for the current year (maybe you can check the income on last year's tax return form for a ballpark estimate of this year's income). Then take a look at your relevant federal and state income tax brackets (including for long term capital gains), and decide how much more income you can have on top of your existing yearly income while staying inside a tax bracket that's comfortable for you. That's how much capital gains you can afford to have this year! Then compare the original purchase price of your investment to the current market value, e.g. if you bought it at $75 per share and it's now worth $100 per share then 1/4 of everything you sell will be capital gains, and if you can afford to have $100k more capital gains this year that means you can sell up to $400k of the assets at current market value because 400 \* 1/4 = 100. If the investment that you want to sell was acquired in multiple transactions over time, e.g. because it's periodically awarded as compensation for your employment, then different shares may have different purchase prices, and thus different capital gains compared to the current market value, or even losses. If you're not ready to sell them all at once, you'll have to decide which shares to sell now. If any of the shares will have a capital loss, sell those first. This may seem to fly in the face of the common "buy low, sell high" advice, but I'm assuming you've already decided that now is the right time to sell some shares, and the shares that have a loss have the best tax consequences for you right now and otherwise have the same market value as any other shares of the same stock. Prioritize selling shares in this order for the best tax consequences: 1. Shares with a loss, especially shares with the biggest losses, so that you can report them as deductions on your taxes. 2. Shares that you've held for at least a year, especially shares with the smallest gains, benefitting from the federal long term capital gains tax brackets. 3. All remaining shares, from smallest to largest gains. If your employer continues to award you with shares that you want to sell, try to sell them as soon as you receive them (i.e. as soon as they "vest"), before the market has had time to change their value, in which case your gains will be close to zero, so that there won't be any significant tax consequences. (However, note that there may be periods of time when you're prohibited from making trades on stocks associated with your employer.) Once you've sold your previous investment, you should estimate how much federal + state income tax you'll have to pay on the resulting capital gains, and set aside that much money from the sale, transferring it to your bank account and keeping it safe until it's time to pay your taxes. The rest of the money can now be used to purchase a new investment! ## Retirement accounts There are special kinds of retirement accounts, like a 401k, that have a special "tax advantaged" status. They are a kind of wealth that you can manage, but isn't really "yours" until you retire. At some point before a retirement account becomes yours, you'll need to pay regular income tax on it (not long term capital gains tax, unfortunately). You have some choice over whether you pay this tax when the money goes into the account now, or when you take it out after retirement, but the important part is that you only need to pay this tax once, which avoids the compounding tax problem discussed in the previous section. Depending on how the retirement account is managed, you may be able to make trades on the investments inside the retirement account even if you haven't retired yet, and there won't be any tax consequences for doing so! So if you're trying to set aside money for retirement, a retirement account is a great place to do so. Unfortunately, there are limits to how quickly you can put money into retirement accounts, so if you want to be saving up even more money for retirement, or you want to be able to access the wealth before retirement, you should be making additional investments with non-retirement brokerage accounts. ## How do rich people avoid paying taxes? 1. Rich people prioritize investments over salary. They might not even take any salary, preferring to get paid in stock. 2. Rich people get most of their income from long term capital gains, which are taxed more favorably than other income. 3. Rich people find creative ways to report deductions, e.g. capital losses on devalued works of art, or charitable donations to their own foundations, or reporting their private jets as business expenses. You can do this too a little bit! When I was a game developer I reported video game purchases as "research" business expenses. Also, you can buy a bunch of different stocks, wait for their market values to fluctuate, then if any of them happen to have a loss, sell those ones and report the capital loss as a deduction, and keep the rest. This is called "tax loss harvesting". You get to keep the money from the assets you sold, which you can then spend on living expenses, but it's technically a "loss" so instead of paying taxes on it you can use it to reduce your income tax! Also, capital losses that aren't offsetting any income in the current year can be rolled over to the next year, so there's no risk in racking up tons of losses. 4. Rich people exploit loopholes to put more money into tax advantaged retirement accounts. 5. Rich people leave their wealth to their heirs, who don't have to pay taxes on inherited wealth even if there were capital gains. 6. Rich people can use their vast wealth as collateral to convince banks to give them lines of credit with very low interest rates and very high spending limits. A line of credit is not wealth, it's debt, and thus is not taxed. They can use these credit cards to pay for their living expenses... and then just not pay off the debt for a while, so that more of their wealth can remain in investments which continue to grow exponentially while the debt's interest grows relatively slowly. If they still have debt when they die, a portion of their wealth will be used to finally pay off their debt and the remaining wealth goes to the heirs. 7. Rich people are "accredited investors" and thus have access to non-publicly traded investment opportunities. 8. Rich people pay wealth managers to figure this stuff out for them and optimize their tax strategy. There are plenty more loopholes not discussed here for them to exploit. 9. Rich people lie or embellish or omit information and hope they don't get audited by the IRS, and if they do get audited, they hire lawyers to dispute with the IRS. Apparently paying expensive laywers is cheaper than being honest. 10. Plain old corruption.