Editor’s note: This article was first published in February 2021, right after the GameStop and AMC rally, and reports of young people making millions are from that moment. The Spanish capital gains tax bands it gives have changed since, as higher savings income bands have been added.
After the market manipulation by Reddit users with GameStop and AMC Theatres shares, and if the reports are to be believed, many young people have made a lot of money. Some have even made millions. Warren Buffett has offered some advice to these young investors on what they should do after a windfall like this if they’re smart.
As you’d expect, Warren Buffett has accustomed us to a certain level of clarity and good sense, not only in his advice on financial investing but also on life in general.
Warren Buffett’s advice after a big, unexpected financial gain
Something almost everyone forgets when investing in the stock market is that your return is your gains minus taxes.
1. Plan ahead for tax season
Once we sell the shares, we turn a gain on the screen into a real gain, and capital gains on shares are taxed. In Spain you pay 19% on the first €6,000 of gains, 21% up to €50,000, and 23% on capital gains above €50,000.
Note that shares aren’t taxed until you sell them, unless they pay you dividends, because dividends are taxed too.
So the first thing to prepare for when you make a big capital gain on a winning trade is to set aside the share you’ll have to pay in tax the following tax year.
This advice seems obvious, but many investors, carried away by the thrill of the win and their momentary genius, decide to celebrate as if there were no tomorrow. Some even come to believe they can spend that money because they’ve struck gold and will pull off the same trick again. And this is where Warren Buffett’s second piece of advice comes in.
See also: Good or bad time to invest in the stock market? Keep an eye on the markets
2. Don’t forget hindsight bias
Do you think you’re a pretty smart investor for having made that much money? Don’t assume you can do it again. Let’s be honest: it was a kind of bet that could easily have gone wrong.
In fact, you made that money on a company whose fundamentals say it isn’t worth much, and what you did was take part in a market manipulation that could just as easily have stopped the share price in its tracks.
Only in hindsight can anyone predict what happened. Don’t deny the role luck played in this bet, because denying luck here comes from hindsight bias: the tendency to think, after an event has happened, that it could have been predicted. That the plan was perfect, your vision crystal clear and every step executed masterfully. And that you’ll be able to repeat your success.
That’s simply not how it works. As Buffett put it, “the rearview mirror is always clearer than the windshield.”
Maybe you can repeat it, maybe you can’t, but don’t bet everything on it. Your windfall may have come quickly and easily, but that doesn’t mean you should treat it lightly.
3. Pay off credit cards and other high-interest debt
If you had any kind of debt and have stumbled into this money, use it to pay off as much of that debt as you can.
You may be tempted to invest in other stocks, riding the euphoria of your quick win, but remember that there’s no more profitable investment than paying off your debts. That’s already a guaranteed return.
However much you’ve made, you’re unlikely to beat Warren Buffett over the long run. So if you have debts at 15 or 18 percent, get rid of them: paying them off would be like already having earned Buffett’s annual return.
Buffett’s view is that paying off credit card debt gives you an immediate return on your investment.
4. Where to invest the gains
Once you’ve taken care of the points above, you can certainly pick stocks to invest in (ideally for the long term) now that you have money. But Warren Buffett advises not to forget to set aside part of it to invest either in your retirement plan or in an index fund.
Those of you who follow me know I’m not a big fan of pension plans, but everyone knows best how to handle their own money.
5. Treat yourself
Splurge a little, Buffett recommends; treat yourself. Have some fun. But make sure you decide what you’re going to spend it on and how much you’re going to spend. And stick to it.
As I always recommend, save at least 70% of any unexpected money you make. Either save it or invest it, but accept that percentage. You’ll thank yourself in the future.
And those are basically Warren Buffett’s tips to follow when you get an unexpected windfall or close a stock market trade with big capital gains.
Featured image: SimLibrarian, CC0 1.0, via Wikimedia Commons.
