Money 401: Investing

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Money 309: Big Decisions – Family Deaths

Investing in general

Investment is the commitment of money to the purchase of financial instruments to gain profitable returns

Economics is an applied philosophy towards the exchange of goods and services, so it’s worth learning the basics of economics (later)

A “portfolio” is an entity’s entire list of assets

An investment advisor can manage your portfolio, but you don’t need one to build wealth if you’re willing to work and learn yourself

Organize your investments together in one document

  • Investment company name
  • Type of investment
  • Amount invested
  • Date invested
  • Contact information for following up on the investment

Investing employs a straightforward idea: buy low and sell high

This applies to everything, from the stock market to running a business

To make substantial returns, spend enough time and energy in investing to become familiar with the process

Money is best gained slowly and patiently across decades, not instantly

Great investing comes from managing assets across an extended period, not in “timing” the market

  • Timing the market with analysis and projections for buying and selling is called “speculation”
  • Over time, your number of investments should grow, irrespective of whether the market is climbing or not
  • Every market naturally cycles up and down
  • Large-scale government intervention only stalls an inevitable plunge

Because of compounding interest, the wealth grows larger the sooner you start

  • Invest as often and as soon as possible, even in small amounts
  • You will need $1,000,000 in assets to sustain a $40,000 a year income after retirement
  • Calculate out how much you must invest to reach your goals

Contrary to most investment brokers’ advice, most investors are more concerned with keeping their money than with making significant risks

  • Most investment brokers make a living on their fees
  • Returns determine the size of most brokers’ fees

The best time to invest is when large-scale global events happen

Look ahead at the future of the market and not behind at what has happened

When markets drop drastically, your emotions are your enemy

  • Hold on to your investments and wait for the market to start climbing again before you get rid of your investment
  • After a market drops, the economy will usually start growing again within a week
  • Instead of thinking about risks, think about opportunities that develop from crises

An investment can provide four possible benefits, but never all four

1. High returns

Inflation and taxes will turn a 10% investment into a 4% return (3% inflation, 3% taxes)

Good investing guarantees that the asset will combat or beat inflation

  • Because of inflation, the value of a dollar today is less than a dollar’s value in ten years
  • The average inflation rate across decades is about 3-4%, but it can vary

Depreciation is one of the most substantial expenses in the world

Observe large-scale trends of the market, not its minute gyrations

  • If you have developed excellent money management skills, you should be unafraid of where the market goes
  • Investor-targeted media panic is often a sophisticated version of the local news
  • If you want reliable investing news, follow quants (quantitative analysts) to see where market trends move

As tempting as it may be to chase high returns, pursue a diverse portfolio instead

  • Play out worst-case and best-case scenarios with calculations to be prepared

Watch for idle cash in your accounts

  • Cash’s value will very likely decrease from inflation
  • The average account has $31,000 in idle cash
    • Assuming 30 years at a 7% growth rate, that can lead to a $20,000 loss in returns
    • Cash can redeem mutual funds, but shouldn’t become that large an amount
    • Keep plenty of cash available, however, if the brokerage firm doesn’t allow for fractional shares since you’d have no money to buy one share
  • Synchronize your accounts with a financial service to keep the idle cash down
  • Automatically reinvest dividend payouts to avoid most idle cash

2. Low taxes

Most investing activities are taxable, meaning that paying taxes may test your saving skills

As a general rule, expect to pay taxes somewhere before you can spend your money

Investing across national borders may incur taxation from both countries

Look at your tax bracket and learn about basic accounting (more on this later)

Limit your trades: the more you trade, the more taxation on that trading

Many times contributing to a charity or selling certain losses can minimize your tax burden

Stay educated about any changes in tax reporting requirements

Some tax treatments manage investments in a tax-favored way

  • Tax treatments aren’t technically “accounts”
  • Fund your retirement in a specific tax-favored order
    1. Anything up to the match an employer gives, like 401(k) and IRAs
      • An employer match directly doubles everything you invest into it
    2. After-tax treatments
      • By taxing before investing, there is no taxation on the returns
    3. Tax-deferred treatments
      • By taxing assets when you withdraw them, you can reinvest them without any tax risk

After-Tax treatments are taxed at first, and then you can invest and gain returns on them tax-free

  • Best if you’re making less than you will when you retire
  • Roth IRAs – best to minimize any tax liability
  • Roth 401(k) – an after-tax 401(k)
  • Coverdell Education Savings Account (ESA)
    • As long as the money pays for college or education-related expenses, there are no tax liabilities for withdrawals
    • Never buy an ESA that freezes your options or automatically changes your investments based on the age of the child

Tax-Deferred treatments require you to pay taxes when the investment becomes your own money

  • Best when you don’t expect a drastic increase in your income
  • 401(k) for corporations, 403(b) for non-profit and government
    • Provides specifically limited options for employees
    • Never borrow on a 401(k), you will be hit with an approximate 40% loss when you leave the company
    • Matching provides excellent returns if the company matches your investment
      • If the company offers a 401(k) plan with limited options (should be at least 20 or so), look for alternatives to that plan for any further investing
      • If the match is very low, such as 1%, its fees may make it an unwise investment
      • If the company doesn’t match the contribution, use an IRA instead to save on fees
  • A 457 is similar to a 401(k), but for government and certain non-government entities
  • When you leave a company with a 401(k), always make a rollover into your IRA
    • Taking the money home will tax it when you cash the check
    • Don’t roll the 401(k) into another 401(k), since it limits options
    • Do the math to find if it’s worth converting to a Roth IRA
  • IRAs (Individual Retirement Arrangements)
    • A tax treatment that can apply to almost any type of investment
    • A bit more flexible than a 401(k) about what you can invest toward
    • Anyone with an earned income can have an IRA
    • SIMPLE IRAs are funded primarily by an employer
    • Simplified Employee Pension IRA plan (SEP) is an IRA that any business, even self-employed, can set up
  • 529 Plans
    • Meant to save for college
    • Use a 529 that leaves you in control of your account at all times

3. Low fees

Since money managers invest for a living, their services aren’t for free

  1. Investment advisory fees can be expensive, especially on mutual funds
  2. Watch for management/maintenance fees, shareholder service expenses and distribution fees (12b-1 fees)
  3. These fees are added together and called operating expenses and called the expense ratio
  4. Costs are passed down to the investor
  5. Beyond that, transaction-related costs can double or triple the total fees
    • Markups – the broker-dealer sells their investment to you at a premium to the market price
    • Front-End Sales Loads – a fee when buying something
    • Back-End Sales Loads – a fee when selling something

The less you pay in commission and management fees, the less drag on your return

  • The worst fees are ongoing for every period
    • Ongoing fees charge fractions of a percentage repeatedly
    • Some of those fees can be from the account merely staying open
  • Try online automated investment firms like Acorns and Betterment
  • Use an online discount broker like Vanguard, Fidelity, E*Trade, Schwab or TD Ameritrade to save on brokerage commissions

One of the most common causes of fees is investor neglect in reading the materials the investment firm provides

  • An employer-sponsored retirement plan will sometimes have higher fees than average

4. Low risk

Risks are always a part of investing

  • Risks are worth taking with a large enough payoff
    • Calculated risks are necessary to succeed
    • Risk-taking can be extremely lucrative when done correctly
  • Losses are a natural component of investment, and your ability to not react to it defines how much it can damage your portfolio
  • Great investors go for a 5:1 investment, where a $1 risk is only worth the opportunity to gain $5
    • A 5:1 investment means being wrong 4 out of 5 times will break even

The risk of the investment should be proportional to the amount of time you must hold on to the investment

  • A general rule of thumb is to invest high-risk based on the formula 100 – your age
    • Age 35: 65% high-risk, 35% low-risk
    • Age 55: 45% high-risk, 55% low-risk

There are many ways to lower risk

  • Diversification reduces portfolio risk with a variety of financial assets (don’t put all of your eggs in one basket)
    • Spread out what you own across unrelated industries and investments
    • Many investors accidentally put their money in indirectly related investments
  • Minimize the number of your trades to avoid making a silly mistake
  • The best way to reduce risk is to do your homework and research before making an investment
    • Don’t invest in what you don’t understand
    • Invest in companies and mutual funds you have a natural intuition for and are passionate about
      • Do you know the industry?
        • Are you familiar with the resources the company needs to operate?
        • Have you reviewed relevant industry expert forecasts?
        • How much competition is in the industry?
        • How successful is the average company in the industry?
      • Does the company’s business model make sense?
        • Is the company’s current mission focused and consistent with their brand?
        • Is the company making an impact?
        • How does the company make money?
      • Do you know the history of the company?
        • Have you reviewed the company’s performance history?
        • Have you compared that performance to competitors and relevant indices?
        • Do you know the financial health of the company?
        • Have the profit margins been steadily changing upwards or downwards?
      • Does the company provide value you believe in?
        • Is the product a sufficient quality for the market it goes to?
      • Do you know what the management team is like (such as their website or LinkedIn)?
        • Are they well-respected and trustworthy?
        • Are the executives given fair compensation?
        • Is there a history of good management from that team in the past?
      • Are the customers a group you can identify with?
        • Are you a customer or want to be one?
        • Do you know who the customers are?
        • Is the customer base loyal?
      • How is it rated in Moody’s and Standard & Poor’s systems?

There are three major investment categories

1. Dividends – getting a portion of something that makes a profit

The most common type of investment in a formal market

There are numerous options, features, and opportunities in dividends if you’re willing to learn them

Stocks

  • A portion of ownership of a company (usually traded publicly)
  • High returns, but high risk
  • Pros
    • High long-term returns of about 10-12%
    • Good for retirement
    • Self-managed taxes
    • Not much time required to learn about and invest
    • May appreciate in price and work as a commodity, depending on the company’s management
  • Cons
    • High risk (you can lose everything if you don’t know what you’re doing)
    • Lack of diversification unless owning 35-50 stocks
    • If a company goes bankrupt, you lose the entire investment
    • Very unlikely to beat the market’s returns (e.g., DJIA, NASDAQ, S&P)

Mutual fund

  • Multiple investors combine many stocks into a pool that a fund manager is paid to buy and sell securities to increase returns
  • Medium returns, medium risk
  • There are many types of mutual funds
    • Index Fund – follows closely to a stock market’s ups and downs (an index, such as NASDAQ or DJIA)
      • Usually the safest and most reliable funds
      • Can be inexpensive and will often be well-diversified mutual funds
    • Growth and Income Fund – big, boring companies that have been around for a long time that sell staple goods and services
    • Growth Fund – a mutual fund made of higher-risk growing medium and large company stocks
    • Aggressive Growth Fund – a mutual fund with very high risk and very high returns
    • International Stock Mutual Fund – a mutual fund made of shares from international companies
    • Bond Fund – a mutual fund made of bonds
    • ETF (Exchange Traded Fund) – a different mutual fund that is a bit like an index fund
    • REIT (Real Estate Investment Trust) – a mutual fund with real estate investments
  • When picking a fund
    • Avoid actively managed funds, since each buy and sell will likely incur fees or commissions
    • Look more at what the fund manager is investing into than their rate of return
  • Pros
    • Built to have more diversification than stocks
    • A good fund manager can stay ahead of the market’s trends
    • Not much time needed to learn about and invest in
    • Can be done with any amount of money
  • Cons
    • An inept fund manager may cause a loss
    • Rises and falls more closely with the stock market than individual stocks
    • More fees from there being a fund manager

Business startup (investing)

  • Investing in someone else’s business idea
  • High returns, high risk
  • Pros
    • Possible chance of tremendous success
    • If you’re good at reading people, your skills will pay off
    • Can be done online now, such as Republic or Startup Stock Exchange
  •  Cons
    • Profoundly connected to the character and work ethic of the team running the business
    • If you trust people too much or too little, you will miss numerous opportunities
    • Crowdfunding rarely provides guaranteed returns

Business startup (working)

  • Creating a profitable business of your own
  • High returns, high risk (depending on the industry)
  • Pros
    • Opportunity to carry your passion into a revenue stream
  • Cons
    • Long hours, low-paid for a long time
    • Need to be the right kind of person for the job

2. Price Appreciation – the item itself goes up in value

Hold onto assets for at least five years

If you are young, consider devoting a decent percentage of your portfolio to price appreciation

Real estate

  • Very high returns, long wait time, high risk
  • If you’re purchasing a secondary property, never own it farther than an hour’s drive from your home
  • Pros
    • A fantastic investment vehicle both as a rental property and in buying and selling
    • Researching and applying many different skills will provide tremendous returns
    • High returns
  • Cons
    • You need to know the area and the market well
    • It takes years to see returns
    • There are high costs to maintain real estate
    • High risk

Collectibles

  • Low returns, medium risk
  • Pros
    • Makes hobbies profitable
  • Cons
    • Not typically very profitable

Commodities and futures

  • Low returns, low/medium risk
  • Pros
    • Generally resistant to inflation
  • Cons
    • High risk, especially in unfamiliar materials
    • Doesn’t provide returns outside of their comparative value from buying to selling

Web Domains

  • Use services like Flippa or Sedo
  • High returns, medium risk
  • Pros
    • Can become very valuable with the right buyer
  • Cons
    • May never appreciate in value

Currencies

  • Pros
    • Geopolitical events can wildly swing its value, causing remarkable gains when timed right
  • Cons
    • Doesn’t provide returns outside of their comparative value from buying to selling
    • More of a safety net than an actual investment vehicle

3. Interest – compounded interest on the amount loaned

Bank Accounts

  • A bank arranges to hold onto and use assets and pays for the inconvenience
  • Dismal returns, nearly zero risk
  • Pros
    • Very high liquidity
    • Allows as a “holding tank” for other investments
    • Practically zero risk
  • Cons
    • Depressingly small returns
    • Horrible idea for long-term investing
  • Includes many varieties of products
    • Checking Accounts
    • Certificates of Deposit (CDs)
    • Money Market Accounts

Bonds

  • A note an organization will borrow with that matures after a certain number of years
  • Low returns, low risk
  • Pros
    • Regular interest income
    • Potential appreciation in value
  • Cons
    • Lack of diversification unless holding 35-50 bonds
    • If a company goes bankrupt, you lose the entire investment
    • Can be treasury bonds from a government entity or corporate bonds from a company
    • Treasury bonds (I Bonds) are very low risk and a very low return

Microloans

  • A bit like a mutual fund, but with loans
  • Medium returns, medium to high risk
  • Pros
    • Gives the opportunity to issue loans without all of the assets
    • A variety of risks and returns based on borrower credit history
    • Many types to choose from, ranging from student loans to consumer debt refinancing to startup loans
    • Easy to invest across international borders
  • Cons
    • Money is completely tied up until needing it
    • Depending on what the loan is for, you may not see all of your investment returned

Watch for scams

A timeshare is a vacation rental, not an investment

Anything that shuffles money around is known as a Ponzi scheme

  • Ponzi schemes always fail and take your money with it

Anything that turns typical people into owner-seller-marketers is a pyramid scheme

  • Though pyramid schemes may persist for decades, they’re a waste of your time (much more on this later)

Gold does not provide dividends or interest as a commodity

  • If the apocalypse occurred, gold would be difficult to exchange for goods and services
  • Buy liquor for the apocalypse to trade for other goods and services
  • Advertisers that buy gold are vendors that can sell it for a substantially higher amount

A Section 770 or Section 702 is the portion of the tax code involved with insurance

Lottery tickets are paying to feel you might win and aren’t an investment

Avoid brokered mortgage notes, since you don’t want to lend to someone banks refuse to lend to

Don’t get lost in the hype

Stick with what you know and are familiar with, not what someone recommends

Always look for opportunities to invest, which often comes from personal experience

On a regular basis, re-balance your investments to most closely match the percentages you want in each type of investment

Try Dollar-Cost Averaging

  1. Put the same dollar amount every month towards the same ratio of investment types you want
  2. Whatever the market does, don’t change your ratios
  3. Change your ratios as you come closer to retirement and your investment goals change

Investing is a plan across decades, so don’t rush it or set your expectations too highly

Your philosophies and values are more critical to successful investing than luck

Fear will kill any chance for significant returns

  • You will never be the “perfect” investor, so don’t try to be one
  • When panicking or following a hot trend, you may make a devastating decision
  • Hoarding cash will erode your portfolio’s value

Listen to the right people

Listen to your significant other’s advice, since it’s also their money

Take your five closest friends and average out their income, and that’s about what your income will be in five years

Get more input from good sources

  • Observe what you are hearing and reading, and don’t pollute your mind with bad investing strategies and philosophies
  • Avoid the soothsayers and prognosticators who say you’ll miss out if you don’t invest now
  • Don’t get caught up in propaganda in news headlines and try to avoid following trends too closely

Consider your investing decisions prayerfully, since God is the master of the markets

Many investment advisors might have a minimum investment requirement

Minimum investing amounts are more for their profit than anything

  • There are many low initial investment portfolio options
  • A professional investor can’t predict markets, but they may often find accurate patterns

Don’t get lost in the rush of investing

Your personal life and health are more important than your portfolio

  • Your primary investment is you
  • Professional development (later), staying balanced (later), and staying healthy (coming up next) are better than wealth

Think how much time you’re spending along with money on investing

If the market starts dropping, go for a walk or do a non-investing hobby and get your mind off it

Understand how each of your investments fits in with your financial goals

Instead of focusing on the problem (e.g., not enough money) focus on the solution

  1. Don’t ask yourself about options like IRAs or bonds
  2. Instead, ask about things like your children’s college tuition or your retirement
  3. Look at the returns you’re getting and find out if you’ll attain your desired goals
  4. Estimate how much you’re willing to lose
  5. Make your exit plan
Next: Money 402: Insurance