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 so as to gain profitable returns
    • Any legal entity’s entire list of assets is called a portfolio
      • An investment advisor can manage your portfolio, but you don’t need one to build wealth if you’re willing to do your own work
    • Keep your investments organized in a single document
      • Investment company name
      • Type of investment
      • Amount invested
      • Date invested
      • Contact information for following up on the investment
  • The biggest way to make big returns is by spending a lot of time and energy in investing
    • All investing, from stock market to running a business, is using one simple idea: buy low and sell high
    • Money is best gained slowly and patiently across decades, not instantly
      • Investing is about managing assets for a long period of time, not in “timing” the market
        • To time the market for buying and selling with analysis and projections is called “speculation”
        • The number of investments you own should over time grow bigger and bigger, whether the market is climbing or not
        • Every market will naturally go through up and down cycles, and even massive government intervention merely stalls the inevitable plunge
      • Because of compounding interest, the sooner you start then the larger the wealth can become
        • Invest as often and as soon as possible, even if it’s in small amounts
      • Contrary to most investment brokers’ advice, most investors are more concerned with keeping their money than with making big risks
        • Bear in mind that most investment brokers make a living on the fees they incur, which are sometimes based on the returns you make
  • 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 the markets drops drastically, your emotions are your enemy
      • The best thing to do is to hold on tight and wait for the market to start climbing again before you drop your investment
      • Usually after a market drops, the economy starts growing again within a week
      • Instead of thinking about risks, think about the opportunities that come from those crises
  • Economics is philosophy applied to the exchange of goods and services, so it’s worth learning the basics of economics

There are 4 possible benefits an investment can provide, but never all 4

  1. High returns
    • A 10% investment can be expected to have 3% inflation and 3% of taxes turn it into a 4% return
    • Good investing guarantees that the money will be able to combat or even beat inflation
      • Because of inflation, the value of a dollar today will be less than the value of a dollar in 10 years
        • The average rate across decades is about 3-4%, but it can vary by a bit
      • Depreciation is one of the largest expenses in the world
    • Pay attention to the large-scale trends of the market, not the minute gyrations in it
      • If you have developed the above habits up to this point, you should be unafraid of where the market goes
      • A vast majority of the time the panic onset by the investor-targeted media is a sophisticated version of the local news
    • As tempting as it may be to chase high returns, pursue a diverse portfolio instead
    • You may want to use a calculator to play out worst-case and best-case scenarios in order to be prepared
  2. Low taxes
    • Keep in mind that most investing activities are taxable, meaning that your saving skills may be put to the test to pay taxes
      • As a general rule, always expect to pay taxes somewhere in the process of it becoming your spending money
      • When investing across national borders, taxes may come from both countries
      • Pay attention to the tax brackets you are in and be educated about taxes
      • The more you trade the more likely you are to get taxed on that trading, so limit your trades
    • There are some tax treatments to manage investments in a tax-favored way, and are not technically “accounts”
      • After-Tax – taxed, and then you can invest with it tax-free
        • 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 one that freezes your options or automatically changes your investments based on the age of the child
      • Tax-Deferred – you pay taxes when it becomes your own money
        • 401(k) for corporations/403(b) for non-profit and government
          • Never borrow on a 401(k), you will be hit with a loss of about 40% when you leave the company
          • Matching provides excellent returns if the company matches your investment
            • If the company is providing 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 the investment not worth it
            • If the company does not match the contribution, you will save a lot of money on fees by using an IRA instead
          • Whenever you leave a company with a 401(k), always do a rollover into your own IRA
            • If you take the money home it will be taxed as the check is cut to you
            • Do not roll the 401(k) into another 401(k), since the options are more limited
            • Do the math and find out if it is worth converting to a Roth IRA
        • 457 for government and certain non-government
        • IRAs (Individual Retirement Arrangements)
          • A type of tax treatment that can be applied to almost any type of investment
          • Anyone with an earned income can have an IRA
          • SIMPLE IRAs are funded largely by an employer
          • Simplified Employee Pension IRA plan (SEP) is an IRA that any business, even self-employed, can set up
        • 529 Plans
          • Meant for saving for college
          • Use a 529 that leaves you in control of your account at all times
      • You should be funding your retirement in a certain tax-favored order
        1. Anything up to the match an employer gives, like 401(k) and IRAs
          • An employer match literally doubles every part that you invest into it
        2. After-tax treatments
          • By taxing before investing, there is no taxation on the returns
        3. Tax-deferred treatments
          • By putting assets in to be taxed when they are withdrawn, they can be reinvested without risk of taxation
    • Stay educated about any tax reporting changes
    • Many times contributing to a charity or selling certain losses can minimize tax burden
  3. Low fees
    • Everyone who manages money has a job, and none of the investing they do for you will be free
      1. Investment advisory fees can be expensive, especially on mutual funds
      2. Also be aware of management fees, shareholder service expenses and distribution fees (also known as 12b-1 fees)
      3. These fees are added together and called operating expenses and called the expense ratio
      4. The expenses are passed down to the investor
      5. Beyond that, there are transaction-related costs that 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 that is taken when investing into something
        • Back-End Sales Loads – a fee that is taken when selling the investment
    • The less you have to pay in commission and management fees, the less drag on your return
      • The worst of the fees can be ongoing fees paid every period, since they will charge fractions of a percentage repeatedly
        • Some of those fees can be just from having the account open
      • Try online automated investment firms like Acorns and Betterment
      • An easy way to save on brokerage commissions is to use an online discount broker like Vanguard, Fidelity, E*Trade, Schwab or TD Ameritrade
    • One of the most common causes of fees is purely investor neglect in reading the materials the investment firm provides
      • Sometimes an employer-sponsored retirement plan will have higher fees than average
  4. Low risk
    • Risk is always a part of investing
      • Risks are great to take when the payoff is worth it
        • Calculated risks are necessary to succeed
        • Risk taking is very financially valuable in specific places
      • Great investors go for a 5:1 investment, where risking $1 is only worth it if you can get $5
        • This means that if you are wrong 4 out of 5 times you will still break even
      • The risk of the investment should be proportional to the amount of time you have to hold onto the investment
        • As a general rule of thumb, 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
      • Losses are a natural component of investment, and your ability to not react to it is what defines how much of a damage it will do to your portfolio
    • There are ways to minimize risk
      • Diversification is reducing portfolio risk by holding a variety of financial assets (don’t put all of your eggs in one basket)
        • Spread out what you own across industries and investments that are not related to each other
        • Many investors will accidentally put their money in investments that are related to each other
      • The number one way to reduce risk is to do all of the necessary 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 understand the industry?
            • Are you familiar with the resources the company needs to operate?
            • Have you reviewed relevant forecasts by industry experts?
            • How much competition is 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?
            • Have you researched how the company makes 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 that you believe in?
            • Is the product of a sufficient quality for the market it’s going to?
          • Do you know what the management team is like, from sites such as 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?
      • Minimize the amount of trades you make to avoid making a silly mistake

There are 3 major categories of investment

  1. Dividends – getting a portion of something that generates profit
    • In General
      • The most common type of item that is invested in a formal market
      • Numerous options, features and opportunities if you’re willing to put in the time to learn
    • Stocks – a portion of ownership of a company, usually publicly traded
      • 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 possibly give price appreciation and work as a commodity, depending how it’s handled
      • Cons
        • High risk
          • If you don’t know what you’re doing, you can lose a lot
        • Lack of diversification unless owning 35-50 stocks
        • If a company goes bankrupt, entire investment is lost
        • Very unlikely to beat the market’s returns (DJIA, NASDAQ, S&P, etc.)
    • Mutual Fund – many 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 usually be well-diversified mutual funds
        • Growth and Income Fund – big and boring companies that have been around for a long time that sell things people regularly buy
        • 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 stocks from other international investments
        • 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) – basically a mutual fund with real estate investments
      • When picking a fund
        • Avoid actively managed funds, since every buy or sell will probably have fees or commissions applied to them
        • Look more at what the fund manager is investing into than the rate of return they give
      • 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
        • If fund manager is inept, there may be 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)
      • High returns, high risk
      • Pros
        • Possible chance of tremendous success
        • If you are good at reading people, your skills will pay off
      • Cons
        • Extremely contingent on the character and work ethic of the team that runs the business
        • If you trust people too much or too little, you will miss numerous opportunities
    • Business Startup (Working)
      • High returns, high risk (depending on the industry)
      • Pros
        • Opportunity to carry your passion into a revenue stream
      • Cons
        • Long hours, low-paying 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
    • In General
      • Hold onto them for at least five years
      • If you are young, you should consider putting a decent percentage of your portfolio into this
    • Real Estate
      • Very high returns, long wait time and high risk
      • If you are purchasing secondary real estate, never own it farther than an hour’s drive away from your primary residence
      • Pros
        • An amazing investment vehicle both as 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
        • Takes a lot of time to see returns and to maintain the properties
        • High risk
    • Collectibles
      • Low returns, medium risk
      • Pros
        • Permits hobbies to become profitable
      • Cons
        • Not typically very profitable
    • Commodities & Futures
      • Low returns, low to medium risk
      • Pros
        • Generally resistant to inflation
      • Cons
        • High risk, especially in unfamiliar materials
        • Doesn’t actually provide returns outside of the comparative value of then vs. now
    • 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 actually provide returns outside of the value between buying and selling
        • More of a safety net than a true investment vehicle
  3. Interest – compounded interest on the amount loaned
    • Bank Accounts – an arrangement where a bank will pay to hold onto assets
      • 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 company goes bankrupt, entire investment is lost
      • Can be treasury bonds from a government entity or corporate bonds from a company
        • Treasury bonds (I Bonds) are very low risk, 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 out for scams

  • A time share is not an investment, it is a vacation rental
  • Anything that shuffles money around is known as a Ponzi scheme, and is guaranteed to fail and take your money with it
  • Anything that turns typical people into owner-seller-marketers is a pyramid scheme, and though they may hold up for a few decades they are not worth your time
  • As a commodity, gold does not provide dividends or interest, and would be a poor way to get goods and services if the apocalypse happened, and typically radio advertisements for buying gold are from people who have a lot of money to gain by selling it
    • Instead, buy whiskey, since that can be traded for other goods
  • If you ever hear of a Section 770 or Section 702, that’s the part of the tax code that deals with insurance
  • Lottery tickets are not an investment, they are an expense to get the feeling that you might possibly win
  • Steer clear of brokered mortgage notes, since you don’t want to loan someone that banks won’t loan to

Don’t get lost in the hype

  • Stick with what you know and are familiar with, not with what someone recommends
    • Always be on the lookout for opportunities to invest, which many times comes from personal experience
    • On a regular basis, re-balance the 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. When the market drops or the market soars, don’t change your ratios
      3. Change your ratios as you get older and your investment goals change
  • Investing is a plan across decades, so don’t try to rush it or set your expectations too highly
  • Your philosophies and values will be more important in determining your investment success than being lucky
    • Fear will kill any chance for you to get any significant returns
      • You will never be the “perfect” investor, so it’s a bad idea to try to be one
      • When panicking or following a hot trend, you may make a devastating decision
      • To hoard lots of cash will erode your nest egg’s value
  • Pay attention to who you are listening to
    • Listen to your significant other’s advice, since it’s their money as well and the relationship needs that collaboration
    • Get more input from good sources, since your own knowledge right now is lacking in some information that could be vital
      • 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 tell you that you will miss out if you don’t invest now
      • Don’t get caught up in propaganda that makes news headlines and try not to follow trends too closely
      • Take your 5 closest friends and average out their income, and that’s about what your income will be in 5 years
  • If your situation merits it, find a certified Independent Financial Advisor (IFA) to help you attain your goals
    • Hire your financial advisors very carefully
      1. Research them through FINRA
      2. Agree on how you’ll work together and on both of your expectations
      3. Gather the relevant information and set goals
      4. Evaluate your financial status and create a strategy
      5. Understand their recommendations and possible alternatives
      6. Have them carry out what you both agreed upon
      7. Periodically, maintain your progress with them and re-evaluate your goals and the arrangement with them as necessary
      8. If you ever have any uncertainties about any potential investment product, take their marketing materials to a certified IFA
    • Many investment advisors might have a minimum investment requirement, but that is more for their profitability than anything else
      • There are many options for low initial investment portfolios
  • Consider your investing decisions prayerfully, since God is the master of the markets
  • As tempting as it may be to get lost in the rush of investing, remember that your personal life and health are more important than your portfolio
    • Don’t forget to consider how much time you’re spending as well as money on investment
    • When the market starts getting bad, the best thing is to go for a walk or do a non-investing hobby
    • Your main investment is you, and professional development along with keeping well-balanced is better than making a lot of money
    • Understand how every one of your investments fits in with your financial goals
      • Instead of focusing on the problem (e.g. not enough money) focus on the solution
        • Don’t ask about IRAs, bonds, etc.
        • Instead, ask about things like your childrens’ college tuition, your retirement, etc.
        • Look at the returns you’re getting and find out if they are sufficient for your desired goals
        • Estimate how much you’re willing to lose
        • Figure out your exit plan
Next: Money 402: Insurance