Investing Lecture Notes

Introduction

• Previous advice: Avoid trying to beat the market by picking stocks.
• Avoid paying high fees for stock-picking services.

Investment Rule #3: Diversification

• Key Strategy: Diversify your investment across various assets.
• Benefit: Reduces risk without reducing returns.
  • "Don't put all your eggs in one basket."
• Example of Poor Diversification: Enron employees had 60% of retirement savings in company stock.
  • Consequence: Employees lost savings when Enron collapsed.

Risks of Investing in Employer's Stock

• Avoid investing heavily in your employer's stock.
  • Risk: Loss of job and savings if the company fails.

Modern Diversification Techniques

• Utilize index funds to diversify:
  • Low-fee funds that mimic a broad market index (e.g., S&P 500, Wilshire 5000).
• Avoid home market bias:
  • Include international index funds or multinational companies.

Importance of Low Fees

• Stock picking is ineffective; focus on low-cost index funds.
• Some index funds have higher fees; opt for low-fee options.
  • Example:
    • $10,000 investment with 1% fee grows to $57,000 in 25 years.
    • Same investment with 0.2% fee grows to just over $70,000.
• Check fees carefully, as they accumulate over time.

Simple Investment Strategy

• Sign up for employer 401(k) plans.
• Invest consistently a fraction of the paycheck in low-cost index funds.

Upcoming Topics

• Behavioral finance findings and market anomalies.
• Exploration of irrational behavior in markets.
• Future lecture: How markets sometimes misbehave.