Looking for an investing 101 book? We’ve got several recommendations for you if you’re looking to read up on how to invest.
Ten Investing 101 Books to Consider
The Bogleheads’ Guide to the Three-Fund Portfolio
This is a must-read investing 101 book for investors looking to understand how to build an efficient and simple portfolio themselves in the midst of an over-complicated and diverse world of financial instruments. If you’re brand new to investing, this is a must read just to get up to speed on funds, what kind of performance you can expect. Investors who already have a familiarity with the basics will still find this book interesting by reading about tax efficiency and other advanced topics. All investors can find suggestions for specific funds to use to build a three-fund portfolio. Buy Now.
Unveiling the Retirement Myth
This book has advanced topics but we can still consider it an investing 101 book because of how masterfully it distills complex topics into basic language readable by an investor of any level. This book is my favorite investing book I’ve read in over ten years. To fully understand planning for retirement and how we must look at portfolio performance differently before and after retirement, this is a must read book. This book is more expensive, but buy it, put it on your shelf, and re-read it every few years. Your future wealthy self will thank you for it. Buy now.
Your Money and Your Brain
A great book to introduce the connection between an investor’s emotions and psychology and how that affects investing decisions. This is a very underrated element in learning how to invest, so it’s strongly recommended. Buy now.
A Random Walk Down Wall Street
This book is considered an investing classic and is essentially a must read for any investor of any experience. For investors looking for an investing 101 book, this book is useful because you’ll learn much about investing performance, expectations and whether or not you can expect to “beat the market.” Buy now.
Four Pillars of Investing: Lessons for Building A Winning Portfolio
Dr. William Bernstein is considered a legend in the investing business, and this book is one of his foundational works aimed at providing individual investors a comprehensive introduction to the world of finance and investing. Not only will you learn strategy by reading this, but you’ll learn plenty about market history, investor psychology and more. Buy now.
Little Book of Common Sense Investing
This is an ideal quick read for brand new investors. If dense, long books with lots of math and academic citations are a turn off for you, then this is the perfect book to start with. John Bogle, another investment world legend, wrote this little book for the regular investor. It’s a great place to start. Buy now.
The Intelligent Investor
This is another one of those anchors for your investing bookshelf that every serious investor should own. Written by Benjamin Graham back over 50 years ago, this is a classic text often referenced by individuals like Warren Buffett. If you’re looking for an introduction to value investing, it’s hard to find a more important book. Buy now.
The Essays of Warren Buffett
This might be an peculiar entry on an investing 101 book list, but Warren Buffett’s essays and letters to shareholders over the years are some of the most important reads in recent decades. Learning from the master Warren Buffett is always a great option, and this book conveniently includes a large number of texts from Buffett himself from over the years. The beauty of this piece and of Warren Buffett’s essays is the timeless information contained within them. Buy now.
This is a bit of an atypical book on this list, but it has important ramifications for investing. The Outsiders is a book about the stories of masterful CEOs that generated outsized returns for their shareholders. While the book provides amazing examples of business success, the book also provides the individual investor great insight into the concept of capital allocation. Return on capital allocation is a core component of successful investing, and you’ll never look at investing the same after reading this book. Buy now.
The New Coffee House Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life
An easy, short read for individuals looking to learn how to invest simply and effectively, but aren’t necessarily interested in getting an advanced degree in finance. The beauty of this book is that you can read it on a single flight or in an afternoon. Also a great gift for fresh graduates from college to introduce them to investing. Buy now.
Which Investing 101 Book Should You Read?
Limited time and only want to a read a single investing 101 book? We’re here to help!
If you’re completely new to investing and want a general overview of how investing works and how to get started, consider either The Little Book of Common Sense Investing or The New Coffeehouse Investor.
Additional Reading: Investing 101
Are you new to investing? If you’re not ready to buy an investing 101 book just yet, the following ten concepts are crucial to understanding the basics of investing
What is investing?
Investing is the act of allocating the capital you have saved into various vehicles with the goal of generating a return over time. Note that investing depends on savings. Savings is the backbone of all personal finance. Without it, there is no investing.
While investing typically refers to the long-term buying of stocks and funds for the purpose of long-term planning or retirement saving, it’s worth noting that there are many forms of investing. Investing can mean contributing capital to your family member’s business, or buying a piece of real estate, or buying a bunch of trees for the acreage you own.
Investing typically means an upfront deposit of cash in exchange for ownership of an asset that you expect will either go up in value or pay you more over time than you put into it. Of course, not every investment makes money. Some investments lose money, even all the money contributed.
Why not just keep money in cash? Well, inflation can erode the value of cash so keeping up with the rate of inflation is one of the basic goals of inflation. Growing your assets over time on top of the inflation rate is also the goal of investing.
How much money do you need to start investing? Very little actually thanks to a plethora of new companies and offerings from existing companies that are aimed at new investors. These companies have reduced minimum investments quite a bit with the goal of gaining new, lifelong customers. Companies like Acorns let you invest your spare change or contribute to your retirement account five bucks at a time. Not bad!
Albert Einstein once said that compounding interest is “the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” Understanding compounding interest and the power of it is crucial for anyone reading an investing 101 book.
At a basic level, you can understand compounding interest as follows. For the first period of time (say, a year), you’ll earn interest on the money you invest. In the next period of time (say, year 2), you’ll earn interest on the money you invested as well as on the interest you earned previous. In the next time period, you’ll earn interest on the original investment as well as on all the interest earned so far. And it keeps going.
Compounding interest can be even more powerful if the rate of compounding increases. This refers to the frequency of compounding. For example, if your interest is compounding daily instead of annually, it’s going to grow even faster.
If you’re looking for examples of how fast a chunk of money can grow, you can find a number of compounding interest calculators online. But, here’s an example for illustration purposes as well:
In the below example, you can see that the first person invests $5,000 each year from age 25 to 35, and the second person invests $5,000 from age 35 to 65. Assuming an 8% rate of annual return for both scenarios, the first person ends up with over $900,000 at the end whereas the second person ends up with just over $600,000 (despite contributing much more).
This important example illustrates a few very crucial things with regards to investing. First, the earlier you start investing, the better. As you can see, it’s better to start early and then stop, then start late and keep going. Start as early as you can. Second, investing over long periods of time can be extremely lucrative. The more time, the more compounding kicks in and generates massive returns.
Another good way to look at this example is as follows: in the beginning of your investing life, contributions are most important. In the latter stages of your investing life, the rate of return is most important.
Study this example and understand it thoroughly. It can change your life.
Types of investments
Any decent investing 101 book will cover the types of investments you might consider, so let’s look at it briefly. As an investor, deciding where to put your money is one of the most important questions. One way to break down the types of investments is to consider them grouped into buckets such as stocks, bonds and cash-like investments. Note that with each bucket, you can put money directly into these investments or in funds or ETFs of these investments. Essentially, you can buy stock of individual companies or you could buy an ETF of stocks. For the consideration of different investment types, we’ll consider the direct purchase of stocks as the equivalent of buying a fund of stocks.
Stocks: A stock refers to a share of an individual company. You essentially own a piece of a company. When companies do well, the value of the company rises as does the stock that you own in the company. You can buy and sell shares of stock on the stock exchanges such as the Nasdaq and the New York Stock Exchange.
Bonds: A bond refers to a loan from an entity such as a government or a business. When a company or a government wants to borrow money, they can issue bonds. If you buy the bond, in one sense, you’re letting the entity borrow your money at agreed upon terms. These terms can include the duration or length of the bond and the interest rate of the bond. U.S. government bonds, also known as Treasuries, are considered some of the safest investments in the investing world. Bonds are a part of the category known as “fixed income” because bond holders expect regular income payments. While bonds can fluctuate in value, typically they are held for income purposes rather than appreciation. The risk involved in holding a bond is typically referred to as default risk. If a company goes bankrupt, they might default on their debt, and you won’t be paid back the loan you gave the company when you purchased the bond.
Cash equivalent instruments: Investors will also invest in cash equivalent assets such as bank savings accounts and certificates of deposit (CDs). A CD will let an investor allocate money without risk of losing the money and earn a specific rate of return. A CD’s interest rate is typically higher than a regular savings account but lower than you’d get on bonds (bonds are riskier). Longer duration CDs will often pay more than shorter duration CDs, because you as the investor need to be compensated for having your money tied up longer.
What does it mean to “own a stock” of a company?
Since the stock market is one of the biggest topics regarding investing, let’s spend a few more moments discussion what it actually means to own stock. But, first, let’s back up a bit.
What companies are listed on the stock market? How did they get there? Why are some companies not on the stock market? Let’s answer these questions briefly. Companies are listed on the stock market when they essentially put up a portion of the business for sale to the investing public. Why would they do this? To raise money, of course. Companies raise money all the time. Sometimes through family and friends, sometimes through private markets, and sometimes through public markets like the stock market. When the company puts part of it up for sale on the market, individuals and funds can then buy chunks of that chunk of the business and own part of the business. The chunks are divided up into shares of stock. Once a company’s stock trades on the stock market, it’s value will now fluctuate day-to-day based on the buying and selling of shares of the company between individuals and funds.
Why are some companies not on the stock market? Well, when you’re a publicly listed company, there are now more rules and regulations you have to follow such as filing specific paperwork (this is so the investing public has the appropriate knowledge of the company’s operations). If a company doesn’t need to raise money and doesn’t want to fool with the extra regulations, they may opt to stay private. Chick-fil-A is a popular example of a very large company that has remained private.
Ok, so now that we’ve covered that, what does it mean to own shares of stock of a company. As a stock holder, you are now an owner of a small piece of the company including the company’s earnings and assets. Mature companies will often pay a dividend to shareholders which is essentially a cash payment that is a percentage of the profit that the company has earned. As a stock holder, you will get dividends deposited into your stock brokerage account. As a shareholder, you also may have a vote or a say in company decisions (though most shareholders voting power is so insignificant, they don’t even fool with it).
You can make money as an owner (shareholder) in the company by collecting dividends and eventually selling the stock (hopefully for more than you bought it for). Once you sell the stock, you are no longer a part of the company and no longer collect dividends.
Any good investing 101 book will cover the topic of diversification. When you begin investing, you’ll probably already know just due to simple common sense that it likely isn’t wise to put all of your money in a single investment. If all of your investments is in a single company’s stock, for instance, you’re embarking on a risky investment path. What if that company hits some serious problems? You don’t want to leave your hard earned savings open to that kind of risk. Diversification is the solution to this problem.
Diversification isn’t just the idea of spreading your bets around, but it’s about execution an investment allocation that reduces risk and volatility as much as possible while maintaining a sufficient level of return.
One way to consider this is to look at stock market sectors. Spreading your bets around 3-5 oil companies might reduce single-company risk, but your investments are highly concentrated in the energy sector. What if a major issue strikes the oil industry? A better approach is to invest across multiple industries and sectors thereby reducing a major downturn in a single sector.
An additional option is to consider geography. It’s common practice for investors to have a bulk of their investments in the U.S. stock market, but also have investments abroad in international companies and stocks.
Lastly, the good news it that in today’s investing world, there are a number of funds and ETFs that can do this for you. There are even ETFs such as the Vanguard Total Stock Market Index Fund (VTSMX) that essentially own the entire stock market. It’s very broad diversification in a single fund. More on index funds and ETFs later.
Long-term investors will often cite the fundamentals of a business or a stock when considering whether it is a good investment. Fundamentals are often mentioned against technical analysis (which we’ll get into next), so what are fundamentals?
Fundamental analysis attempts to assign a value to a stock based on the business and economic factors impacting the stock itself. Then, based on the estimated fundamental value, a buy or sell decision on the stock can be inferred.
Examples of fundamentals often include things like the company’s cash flow, return on invested capital, earnings growth, competitive advantage, etc. Often times, investors will look at earnings and attempt to value stocks based on the price-to-earnings ratio (often called the PE ratio). If a stock is trading at $50, and it’s earning $5 per share, then the PE ratio is ten.
Looking at a PE ratio without any context, however, is a problem. Growth rates significantly impact what investors deem an acceptable PE ratio for a company. If a company is growing revenues 50% year over year, the PE ratio will be much higher compared to a company growing revenues 5% a year. Also, PE ratios can vary across sectors. A utility company typically will have a much lower PE ratio than a technology company.
Fundamental analysis works best when looking at the long-term prospects of a stock. While the stock market can fluctuate in a seemingly random fashion over the short run, most investors believe stocks will move towards a true, fundamental value over time. With that said, companies are susceptible to external factors such as trade wars, Fed policy and economic downturns. Fundamental analysis isn’t perfect, but is a worthy piece of the puzzle to consider as you invest in stocks.
Technical analysis differs from fundamental analysis in that it doesn’t focus on business operations or economic indicators. Instead, it focuses on the action of the stock itself. It focuses on things such as stock price, trading volume and other trading signals. Technical analysis often involves analyzing stock charts and identifying patterns, and then as a result making an educated guess on whether a move up or down is imminent in the stock.
It’s worth noting that many would say technical analysis really isn’t “investing.” Rather it’s a trading strategy. While investors are typically attempting to build assets that generate a return over time, traders are looking to make short term bets by getting in an out of positions over quick time periods. Regardless, any investing 101 discussion of the stock market will involve a basic introduction to technical analysis. If you want to dig in further to this subject, there is a myriad of material available for your review online.
What is “the market” really?
“The Market.” It’s a funny phrase, and you hear it all the time. If you watch CNBC, analysts will talk about the market as if it’s their neighbor. The market is reacting to X. The market thinks Y. So what is the market exactly?
Well, first, the market is the stock market. But specifically if someone asks how did “the market” do today, they are asking what did one of the major stock market indices do today? The major stock market indices are the S&P 500, the Dow Jones Industrial Average or the Nasdaq.
Many times, you’ll hear somebody say that the market is up 100 points today. Typically, what they mean with this statement is that the Dow Jones Industrial Average is up 100 points. Despite only being a narrow look at 30 large companies, the Dow is still the most cited index by regular investors on a daily basis. You could argue that the S&P 500 is a much better indicator of where the stock market is since it’s a broader look at 500 large companies.
Daily movement in the stock market is based on the buying and selling of individual stocks. However, the indices such as the S&P 500 index are often weighted by market cap. An $800 billion company in the S&P 500 has a larger “weighting” than, say, a $50 billion company. The larger weighted companies can move the index more than a smaller weighted company.
Index funds & ETFs
Index funds are a type of mutual fund (or often an ETF) that is constructed to match and track the components of a major index such as the S&P 500. These index funds are very popular because they provide investors an easy way to achieve broad diversified exposure with low fees. Rather than attempting to construct a diversified portfolio manually, an investor can simply buy an S&P index ETF and achieve full broad market exposure at super low fees. Considering that most actively managed funds fail to outperform the market, index funds have soared in popularity in recent years.
In one of our major investing 101 book recommendations above, The Bogleheads’ Guide to the Three-Fund Portfolio, the author cites a number of benefits of using index funds as the backbone of your investment portfolio. Things such as no advisor risk, no asset bloat, no index front running, no fund manager risk, no sector risk and more are cited as appropriate benefits of using index funds.
Moreover, for wealthy investors who pay attention to things like tax cost ratio and the tax efficiency of various investments, index funds are often quite tax efficient. Which brings us to our next point…
You can’t map out a set of principles that should be included in any investing 101 book without getting into tax-advantage investing. While this subject can get quite complex and any thorough analysis should include discussions with a CPA professional, we will take a look at the basics.
At the most basic level, investors should be utilizing tax advantaged accounts such as 401(k)s and IRAs. First, it’s important to note that a 401(k) and IRA is a type of investment account, not a type of investment. You can put the same kinds of stocks and funds in any investment account, but how they are treated from a tax perspective can differ based on the account.
Utilizing a 401(k) for retirement saving and investing can be a great plan for many reasons. First, 401(k)s often come with company matching which can essentially be free money. Second, the IRS lets you contribute pre-tax money into the account for your investing which lowers your tax bill now. Traditional IRA’s are also treated similarly.
Roth IRAs differ however by letting you contribute after-tax money, but the withdrawal of this money later is tax free. So, by combining a 401(k) and a Roth IRA, you can achieve both tax advantages both now and in the future.
Note that capital gains don’t come into play in tax-sheltered accounts such as 401(k)s and IRAs. You aren’t taxed at the transaction level. Instead, unless it is a Roth, you are taxed when you withdraw the money as income (not capital gains).
Also, if you’re combining taxable brokerage accounts with tax-sheltered retirement accounts, many investors suggest putting the bond funds inside the tax-sheltered accounts and equity funds in taxable accounts. The reason for this is because bond funds are typically less tax efficient. You can read more about this here and here.