Foundation For Smarter Investing…
There are certain investing basics that you’ll want to know before you invest in anything. I like to call these the “Bricks”, which lay the foundation for smarter investing. The Bricks I’ve shared so far help you know what type of investment makes the most sense for your financial goals. In another article, I shared the B, which is for Benchmark, and it helps you both measure and estimate future potential investment return. To read about investing basics #1, click here.
A few weeks ago, I shared with you investing basics #3, the Index Concept. To read about the “brick” #3, scroll down.
I also shared with you investing basics #4, Cycles. To read about the “brick” #4, scroll down.
As well as investing basics #5, Kind of Investment. To read about the 5th “brick,” scroll down.
The final “brick,” is #6, Strategy. To read about the 6th “brick,” scroll down.
The second “Brick”, which begins with an R, as we spell out Bricks is Reason you invest, and it’s so logical. That’s the thing about investing; it seems overwhelming and all of this investing lingo can be confusing but it’s really very, very basic. Ask yourself: “What’s the reason I want to invest?” Your answer will help you know what to invest in.
Reasons For Investing…
There are two main reasons you invest, and then the third reason has to do with combining the first two reasons. The very first reason that you would invest is because you want your money to grow over time. That’s also called capital appreciation in investing lingo. And it kind of makes sense; your capital is your money, and it grows, or appreciates, over time. This reason is also called growth, which makes sense.
Investing for Growth…
A lot of people associate growth type of investments with retirement funds because investors are putting aside money with the intention of using that money to live at some point. The investments have appreciated in value; the earnings from those investments haven’t been used. This is how you typically think of growth. That is one of the main reasons you invest.
Investing for Income…
The other main reason you invest is for income. That’s for people that have said, “All right, I’ve got enough money now to live off of my money, my capital, my savings, and I’m going to start investing in things that pay an income back to me.” Income investing is something that people typically do when they’ve retired but it can also be something that people do if they’re in job transition, and for a little while, they need to take advantage of income generated from their investments, or maybe even use that money, or the income from their investments to live until they get another job. Perhaps an investor is launching a business as a more permanent income source, and she is temporarily living off of her investments, but typically income investing is associated with retirement.
Growth vs. Income…
It’s very simple; with growth as a reason, your money is going to increase in value. With income as a reason, your money is going to pay you, and you’re going to actually collect that money, either in your bank or your investment account. It’s income, and it’s going right into your banking account, or wherever it is that you choose to put that money.
Combining The Two…
Now, the third reason to invest is both appreciation and income. Those are investments that grow or increase in value, and that pay income, too. The example I like to give of this ideal scenario is actually not a traditional investment, although there are some traditional investments that appreciate in value and pay income, such as preferred stocks or possibly bonds. But, the example I like to give is rental real estate, because it’s common to invest in rental real estate that appreciates in value, especially when you’re buying into the cycle at the right time. When you’re paying the right price for the real estate, you’re buying it low-priced. There’s a good probability (my favorite investing word) that it’s going to increase in value, but it’s also going to pay you rental income if you’ve got units that are rented out from that investment in real estate.
In summary, the second “Brick” stands for R, and it’s the Reason you invest. It’s either for growth, income or both. Once you figure that out, and it’s really not even figuring it out, it’s more of a decision, you have clues as to what type of investment achieves your financial goals.
Ask: “What do I want right now from my investments?” You could decide, “Ah, I’ve got enough income to live; I’m living a nice lifestyle, I think I’ll just put it aside and let it grow.” Or…“You know what, I’m retiring in a year or two, and I want income. That’s the reason I want to invest near term, for income.”
Smart investing, then, is first making the decision why you want to invest. Then you’ll know what to invest in because different types of investments fulfill those different reasons that you’re looking to invest your money. The Reason is the second brick in the foundation of investing basics that you’ll want to know before you invest your money.
#3: Index Concept…
So, you have probably heard of an Index. An Index is simply a basket or a group of stocks or investments that have a commonality. For example you have probably heard of the S&P 500, that’s 500 stocks big companies in the US Stock Market, it’s called an Index.
Why have an Index?
The Index allows you to purchase just an Index, instead of buying 500 different stocks, little bitty investments in all those different stocks. So, it represents the market as a whole, broad market.
Importance of Index…
It’s very important for a couple of different reasons and it’s a benchmark. It also allows you to invest in a diversified and very low cost way, especially when you think about if you are investing in the US Stock Market.
Remember, the I in “Bricks” is for Index, and that’s a concept that you need to know.
The “C” stands for cycles. We all have been through cycles. If you’re old enough to be watching this, and thinking about investing – you’ve seen some cycles. Especially over the past decade and a half. We had the crazy 2000 decade, where we had the major, major correction in the early 2000’s. And then we had another major correction – devastating depression in the 2008 period.
Awareness is Key
This concept is hugely important, and all you have to do is simply aware of cycles when you invest. You may have noticed this if you own your own home. You’ve noticed you can buy a house way cheaper when everybody’s selling their houses. That means the real estate cycle is down. And you’ll pay more for a house when the real estate market is booming, and it’s near the top of a cycle. The stock market and the bond market are the same way.
Whatever you’re investing in, be aware of cycles. Does that mean that you should only invest when cycles are just right? No, they’re never just right. It’s impossible to guess just right. But as my dad used to tell me when he taught me about investing, “It’s hard to catch the top, it’s hard to catch the bottom. But, try to buy or sell somewhere near the top or bottom.”
We could all pretty much see in 2009 that the market had bottomed out, and it looked like it was heading back up. That’s when it’s super, super scary though to invest. And then the market has gone straight up since then. Who knows – by the time you read this, what will have happened. But know that markets work in cycles, and they move up and down. It’s important to be aware of it.
#5: Kind of Investment…
The K in “Bricks,” is simply is knowing the kind of investment that you are making. Before you make an investment, or if you already have some investments – just look at the investment and ask yourself, or ask your financial adviser, if you work with one, “What kind of investment is this?”
Major Types of Investments
The major kinds of investments are stocks, where you own a tiny little piece of the company. Bonds, where you have sort of like loaned money, and you are getting paid interest in general for loaning that money. Or another type of investment, an index fund, which I discussed earlier in this article.
What Kind of Investment Is This?
Ask: Is it an index fund, or do I have a stock fund that is invested in a lot of different stocks, based on certain criteria. Is it a mutual fund? Is it a privately managed account? The more you know about the kind of investment it is, the more empowered you are, and the more confident you can be about understanding your investments.
Now for the final “Brick” – S, is for Strategy. Strategy is very important. It simply means – do I have an overall strategy for my investing? What is my overall strategy?
Ask Key Questions
Part of that involves all the other Bricks I have talked about in this article. Make sure you answer each of those questions. But also ask yourself, “What is my strategy tied to my financial goals? When do I want this money? What do I want it to do?”
Also, super important, “Is my money invested in the most tax efficient way?” For example, do you have investments that pay income when you really don’t need the income right now, in accounts that are taxable? So, are you paying taxes on income that you do not need right now? That would be an example of strategy.
The Big Picture
Look at that overall big picture. That big strategy, and make sure that you have got your assets and your investments placed in a way that they are efficient from a tax standpoint. Make sure they are invested in a way that ties back to your reasons for investing. Whether those reasons are to grow over time, or whether it is to pay you income. All that is going to depend on you, where you are right now in your life, and what you want with your life and your financial goals.
As part of strategy, you may want to work with a financial adviser or a financial planner. You can come see me at Financialwoman.com to begin.