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 share here help you know what type of investment makes the most sense for your financial goals.
#1: Big Picture…
You may feel unsettled about investing in the stock market. It may feel like this big intimidating arena that you know you need to master. You may keep managing to avoid either investing in it, or understanding it. That’s okay. You’re not alone.
Many people have a constant nagging feeling that they need to be invested in the stock market if they are going to have money for retirement one day. In our culture, the prevailing message about having enough money is this: invest in the stock market or you’ll run out of money! It’s true that investing in the stock market over very long periods of time—exceeding twenty years—has enabled investors to accumulate wealth. A lot of this success is due to the magic of compounding. The other part of the equation is that the stock market does have positive results over very long-term periods.
When the earnings from your investments are put right back into that same investment repeatedly over the years, and that investment has positive long-term performance, that money compounds. Compounding is an ideal way to accumulate wealth, which requires no work beyond monitoring your money.
You may have experienced wealth compounding when you looked at your investment account for the first time in a long time and noticed that the account increased in value without any work on your part. It feels great! Albert Einstein referred to compound interest as the greatest invention in human history.
All of this is to say that if you have a long time until you’ll need your investment money, investing in the stock market passively makes sense for many people as a core part of their wealth accumulation strategy.
Before you invest in the stock or any other market, however, you’ll do well to look at your Big Money Picture. This is the first step in investing your money anywhere because it lays the foundation for being strategic with your money. Traditional stock investing, as described above, is simply a step in your overall strategy for accumulating wealth, not a guarantee that your money will outlive you.
Steps To The Important Big Picture Money Perspective
Where the Heck Am I Now?
First, make a list of everything you own, and subtract everything you owe. This is where you are right now. In investing lingo, it’s your net worth. Once you have this, you can contemplate your next move strategically instead of acting on an assumption that picking some stocks will somehow magically lead to your financial goals. Before you start buying shares of the next Apple, ask yourself these questions to lead your wealth.
What do I want my money to do for me?
This question defines the reason you’re investing. The answer to this question would be to either increase your income now, or grow your money over time. (There’s more on this below under the Reason for investing section.) Some awesome investments will do both, but most won’t, so you’ll want a primary reason you’re investing. This primary reason will define the type of investment you’ll buy. Click here to see my video on the Reasons you invest.
Do I want to be actively involved in investing?
The answer to this question will lead you toward the type of investing you’ll do. Many successful investors only invest in real estate, or their own small business. These investments both require active involvement.
If you don’t want to be actively involved with your investing, then investing in stocks is an option to consider. You can invest in stocks with or without much involvement. If you’re leaning toward buying individual stocks, ask yourself if you enjoy researching stocks and other investment opportunities. Do you enjoy news about stocks and the economy? If not, you’re probably going to want to buy index funds or hire a financial advisor to invest for you.
Is investing in the stock or other markets the best use of my money right now?
If you’re paying high interest on any debt, investing may not be the best use of your funds until your debt is paid. Look back to your list of what you owe. Compare the cost of what your loans cost you, after tax, to what you can reasonably expect to make from investing that money.
Can I use some of this money to increase my income?
Increasing income is usually at least as important to wealth building as investing is. Ask if there’s a course or certification that could increase your earnings ASAP. Increasing income allows you to accumulate more wealth and live the way you want. As you may have read before here at Financial Woman, you don’t get wealthy through traditional investing unless you already are. Increasing income fuels wealth accumulation.
Do you have an entrepreneurial spirit? Don’t blow lots of your investment money on the remote chance of an idea making millions. Always test income ideas with as little money as possible. Most people can start a small consulting business to increase income right away at virtually no cost. Kendra Scott began her empire selling a few pieces of jewelry to a local Austin store with her baby strapped to her chest. That jewelry required a very minimal investment while testing her market. As we’ve all seen since, Kendra Scott is smart and strategic.
Is the investment I am considering expensive or cheap based on history?
The answer to this question is more important the shorter your investing time frame. In other words, will you need or want this money within the next three years vs. in 25 years? Believe it or not, you can buy investments when they are cheap vs. overpriced, just like those cashmere sweaters in May vs. November. Learn more about this important and often overlooked investing paradigm in my free eBook which summarizes all of these important investing basics here.
Am I Making Assumptions?
Making assumptions leads to herd mentality. The greatest investors think outside of the box, not with the herd. Don’t limit your thinking to investing only in stocks and bonds. Consider small business income, real estate, and even your own home ownership in your wealth accumulation strategy. Homes are often the biggest investment you make. Is there untapped wealth opportunity there for you?
For example, some savvy couples buy a house that needs TLC, fix it up, and sell it after having lived in it for two years. As I write this, you can sell a home without paying taxes on the gain you make when you sell that house with some very easy rules you’ll need to follow. Think of the incredible value of adding $100,000 tax-free every two or three years to your investment portfolio! Yes, moving is inconvenient, but so is not having enough money to live the way you want. Which one is more inconvenient?
Should your home really be considered an investment? Homes require a lot of your money, and can be used to increase your wealth. If you want them to be a part of your wealth accumulation strategy, then they can be, and they are an investment.
Leading Your Wealth
This unconventional type of thinking is not what you’re going to get mainstream. You’re not going to hear this from a traditional financial advisor, either. This is why you are the best person to lead your wealth. From that leadership, you’ll choose to invest in the stock market if that makes sense for you. You’ll decide whether to hire a financial advisor or do your own investing. You’ll construct ways to increase your income. Investing is way bigger than choosing a few stocks or mutual funds. It’s about wealth creation and accumulation with all of the assets you have, including your skills. Investing is about wealth management. Get comfortable with all of these terms in relation to your money. Lead your wealth.
In other words, look at your Big Picture before throwing money into the stock or bond market. Then make stock investing a part of your overall investment strategy, if it makes sense, to get the results you want from your money.
The second “Brick”, which begins with an R, as we spell out Bricks, is the 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. These are investments that grow or increase in value, and 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.
Reaching Your Goals
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.
If you want my free Bricks eBook which organizes all of these important foundation investing basics and more, click here to get it now.