Investing 101

If you read and understand this entire guide, you’ll have the basics you need to get started. 

After you read this guide, the only thing left for you to do will be to take action. Don’t worry; we’ll guide you through the process in the following sections of this investing article.

What Is Investing and Why You Should Care

Investing, at its heart, is the trading of your money today for the possibility of a lot more money in the future.

The investing we talk about revolves around the stock market. That said, putting your money into a business you create, or a home you will live in, can also be considered an investment. Investments by definition are high yield over the long term. Operative word being long term.

There are people who are afraid of the stock markets – something we will address later in this article. One common approach of these people who fear the market is that they put the majority of their money into a combination of checking and savings accounts. They do not realize that the value of their money is decreasing.

As it turns out, just like how banks like to sneak fees on you, they also don’t like to give away their money. That mindset is reflected in the interest rates of checking and savings accounts.

When you deposit your money in the bank, the bank turns around and invests that money at 7% a year or more. After they collect their profit, they give a tiny shaving of it to you. But wait, that’s your money they are investing, you deserve a bigger cut!

The only way to combat the bank taking advantage of you is to just invest it yourself.

The Question is, Why Invest?

Let’s take a look at a simple comparison to what you would earn with an investment account versus a savings account of a $1,000 investment for 5 years.

With an investment account with an 8% average annual return, you’ll generate a total return of $1,469.33 in 5 years. In contrast, you’ll  generate only $1,025.25 in 5 years in a savings account at a .5% interest rate.

A checking account is normally established to write checks for merchandise and bill paying. A savings account is generally used to save up for future purchases such as: a trip, a car, holiday funds, possibly a home, jewelry, etc. 

An investment account gives you an opportunity to buy stocks, bonds, mutual funds, and other alternatives for a possible return. It’s a risk vs reward investment. 

The Meaning of Portfolio and Diversification

Whenever you read about investing 101 you’re bound to hear the words Portfolio and Diversification.

What do they mean and why should you care?

In the above picture, you can see a silhouette of you at the top of the tree. Everything you own is considered part of your portfolio. Your retirement accounts, your investment accounts, even your home are types of investments.

What you don’t see in this image is a checking account, savings account or debt. Why? Because none of those are investments, they are all short-term assets. Your portfolio reflects your long-term wealth building strategy – not the short term.

You’ll notice that we describe four general types of investment assets: Stocks, Stock Funds, Bonds, and Bond Funds.

Sure there are many more investment mixes, but we didn’t want to distract from the ultimate point of the illustration. To show what diversification looks like.

Diversification is, at its simplest, a way to describe owning multiple types of investment assets. To go a bit further, diversification describes a whole slew of investment categories.

For example, one of the biggest investments people make in their lifetimes is purchasing a home. However, a home is but a single piece of property with a very specific geographic location in a single city/town. This could be considered very risky because what if the area floods or becomes less popular or the home collapses. The best way to account for these scenarios is not to worry yourself sick but to diversify.

This means contributing to a tax-advantaged account like a 401k and IRA. These accounts will both save you money now and possibly earn you great returns in the future.

How do we know you may generate great  returns?

We know because they are accounts which are locked down forcing you to invest in the very long term. We’ll go into more depth on this long-term investing idea in the next section.

Other than 401(k), 403(b), and IRA (Roth IRA)’s accounts, you should open up your very own personal brokerage account. There are very solid brokerages around such as: TD Ameritrade, Charles Schwab, Fidelity, E-Trade, Betterment, Robinhood, etc. This is your playground if you choose to play.

In your Brokerage account, you can take risks on companies like Apple or Tesla or invest in high performing Mutual Funds or ETFs that we discuss on our blog. Why do this? Maybe because you’re interested and want to see if your gut instincts can help build your wealth faster. This is something we encourage but only under the umbrella of diversification. 

Diversification is smart because you both protect yourself from failure and position yourself to take advantage of multiple robust methods for building wealth. To not diversify can be extremely risky.

The Triumph of the Average Investor

The beauty of the market is that it’s anything if not consistent. When you ignore the things the media blows out of proportion on a daily basis, the movement of the market can really be explained by its three base components. Productivity growth, the short-term debt cycle and the long-term debt cycle.

Productivity Growth

This is equivalent to technology getting better, faster and us constantly learning from our mistakes. We will always be able to do more with less time and resources than we were able to in the past. That is productivity growth in a nutshell.

Short-Term Debt Cycle

This cycle is defined by a growth period and then a recession period. These cycles last about 5 – 8 years and should explain why you always feel like the market is booming and busting (because it is). The short-term debt cycle peaks when loans become more expensive (interest rates go up).

Following the bust, rates reset at a nice low level to start the cycle over again. What causes the short-term debt cycle bust? It’s caused by when the payments of debt in the market exceed the income in the market. This leads to a recession, otherwise known as negative growth.

Long-Term Debt Cycle

This is similar to the short-term debt cycle only much bigger and it takes much longer to play out – typically 50 years. Consider September 2008 before Lehman’s collapse as the peak of the long-term debt cycle. The long-term debt cycle peaks when the economy is saturated in debt and it literally can not take on any more. This causes massive deleveraging, a process where the large amounts of debt unwind although not without a lot of lenders losing a lot of their money.

Why are we telling you all of this?

We’re telling you this because it’s important to understand that the market works in cycles. It will constantly go up and down, up and down. Once you know and understand the market you can stop fearing it and start using it to your advantage.

The one truth is that in the long term, productivity will go up so over the long term so will the stock market. This graph is on a roughly 100-year scale. It’s easy to understand all zoomed out but when you’re in the thick of it, it’s hard to see where you are in the cycle. Don’t worry, all you need to do is hold on the long term and you will do just fine.

Now, that’s a lot of information and we didn’t even mention The Average Investor and what that means.

The Average Investor

The Average Investor is someone like you and me who don’t try and time the market, but instead – buy low and sell high. What’s the point? It’s going up over the long term and who has time to obsessively check stock prices?

Not only does The Average Investor not try and time the market but they also don’t try to beat the market. They just try and achieve average returns. Luckily for The Average Investor, the market average is conservatively at 7% (10% on the high end). Not bad!

At the high-end (10%) for The Average Investor, says that if you invest a certain amount of money for 10 years, at the end of that term you should expect it to be more than 10 times larger than your initial investment.

Translation: Average is pretty damn good.

Basically, being an Average Investor is a great goal because it doesn’t involve a lot of work or stress and locks in a nice healthy return over the long term. There is a practice called dollar-cost-averaging which is a genius strategy (says Warren Buffett) in that you invest a certain amount of funds on a consistent basis – say $50/month – and not worrying about what the price of the stock is at that moment. When you average the cost you paid for the stock each month (lower/higher stock prices) over time, you win because the average cost is usually lower.