If investing feels complex and scary to you, you’re not alone. It feels complex and scary to most people. Part of the reason it feels this way is because financial experts talk with lots of jargon and unknown terms. This feels intimidating. (I’ve discovered that because these experts live in a data and analysis world, this is not any more deliberate than a techie that speaks jargon, but it’s intimidating, nevertheless.)
Add to this intimidation the fact that there’s a lot of emotion tied to money because it provides the most basic of human needs: food and shelter. Money determines the quality of your life; Organic vs pesticides; bus vs jet; hamburger vs. ahi; air conditioning vs. fan and even home vs. shelter.
Later, money determines whether you’ll be struggling to pay your light bills or traveling the world during your golden days, and the worry in the years before then. It determines whether you’ll live in the stinky nursing home with bad food and poor service, or whether you’ll be dining in style with the care that you want, if and when the time comes. Either way, maintaining a good quality lifestyle is on your mind somewhere, even if it’s lurking way in the very back of it.
This all means one thing: Your money is super important in a very, very big way. It is right up there just under health and family importance, and it even directly affects the quality and time you get to spend with your family, and your health, in many ways.
It’s important for sure. Why, then, don’t people spend the time to learn just the basics so they can manage their money well? Because it feels big and intimidating, and we procrastinate what feels big and intimidating, even when it’s very, very important.
Given all of this, it’s no wonder that everyone thinks that investing is too complex. I have some wonderful and exciting news: It’s not. Grasp the 6 investing basics concepts outlined below, and you’ll be well on your way to more confident investing.
# The 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, your money compounds. Compounding is an ideal way to accumulate wealth, because it 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 stock 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, strategic and has built an empire.
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, because they are almost always focused on investing only in stocks and bonds. 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. Remember, the B in Bricks stands for your Big Picture.
The second investing basic you’ll want to consider before you invest is simply the reason you’re investing. This is so simple, yet it is often overlooked as a starting point. Just ask yourself; What’s the reason I want to invest? Your answer will help you know what to invest in from among the thousands of choices.
Reasons For Investing…
There are two main reasons you invest, and a third reason which combines 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. This makes sense; your capital is your money, and it grows, or appreciates, over time. This is also commonly called “growth” investing.
Investing for Growth…
Growth investing is often associated for future retirement funds because investors are putting aside money with the intention of using that money to live at some point. These investments will ideally increase in value.
Growth investing is usually the goal for young investors. Investments that grow over time are chosen to build and compound, such as high growth stocks, and other types of investments that are undervalued. The intention is that the money will grow and be used later in life.
Investing for Income…
The other main reason you invest is for income. This is for people that have earned or grown enough money so that they can choose to live off their money. Income investing is done by investing in assets that pay an income back to the investor, such as stock dividends, interest, or rental real estate.
Life circumstances other than age can drive an investor’s reasons for investing. While income investing is something that people typically do when they’ve retired, it can also be done for short periods when income is lacking, such as job transitions, or during the launch of a new business.
Growth vs. Income…
Just remember, when growth is your reason for investing, your money is going to increase in value. With income as your reason for investing, your money is going to pay you.
Traditional retirement planning focuses on income investing coupled with withdrawing money to live on during retirement. Think of how nice it would be if you accumulated enough wealth, and had strategic income investments, so that income investing covered your lifestyle expenses. Then you wouldn’t need to worry about running out of money because you withdrew too much. To me, this is true financial freedom.
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.
Another scenario where you can earn income while your money is growing is from buying dividend paying stocks that are bought near the bottom of a market cycle. If you continue to own the stocks of good companies while the overall stock market rises again, the value increases. The same is true for most bonds.
In summary, the second Brick stands for R, and it’s the Reason you invest. You invest for growth, income or both. Once you know this, you have good clues about the type of investment you’ll want to achieve your financial goals.
#3: Index Concept…
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. This index represents 500 stocks big companies in the US Stock Market. You may have also heard of the Dow Jones Industrial Index, often referred to as “the Dow”.
There a thousands of indexes. Indexes (also called “indices”) exist for small stocks, large stocks, international stocks, commodities, and all types of bonds. They exist for every major type, and category, of traditional investments. In the US, the S&P 500 is the index that is most commonly thought to represent the market as a whole.
An Index Makes It Easy to Invest in Stocks and Bonds
The Index allows you to purchase that big group of 500 different stocks instead buying a tiny amount of all those different stocks. Just imagine how much easier that is for an individual investor! Don’t think that only novice or small investors buy index funds. Index funds are a very common way for financial advisors and institutional money managers to invest.
Diversifying among different kinds of investments (called asset allocation) is easy to accomplish by buying different types of indexes, such as a few stock indexes, bond indexes and maybe a real estate or commodity index.
The Importance of Indexes…
The index is very important for a couple of reasons. First of all, the index serves as a measure of how your investments are performing. When an index is used for measuring performance, it’s called a benchmark. Here is how it works:
Let’s say you are invested in a US stock mutual fund that has about the same amount of risk as the overall stock market, or the S&P 500 index. If your mutual fund returned 5% one year, and the S&P 500 index returned 12% that same year, you’d want to check into why this happened. (This actually happens.) As you can see, the index gives you a fast and easy way to make sure your investments are performing as well as they should be when compared to investments with similar risk.
Not only this, but when choosing an investment, you can use the index to help you evaluate a mutual fund or other type of fund. Rule: You’d expect the fund to perform at least as well as the index. You could even rationally expect the fund to do better than the index over time since the fees are usually higher for a mutual fund that has to pay a manager for researching and selecting stocks.
The second important reason indexes are so important is because they allow you to invest in a diversified and very low cost way, as you saw above.
Remember, the I in “Bricks” is for Index. As you can see, this is a super important concept that you need to know.
The “C” stands for cycles. If you’re old enough to be reading this, and thinking about investing, then you’ve seen some stock and real estate cycles, especially over the past decade and a half. We had the crazy 2000 decade, where we had the major tech bubble bear market in the early 2000’s. And then we had another major bear market in 2008 with a devastating depression.
Some investments, such as short term bonds, have cycles that don’t have as much movement, and most other investments, such as stocks, have huge cycle swings. Again, you’ve likely experienced the real estate cycle with your home, or in your retirement account, so you’re probably familiar with this reality already. As you know, millions of Americans went broke by ignoring the real estate cycle in the 2000’s. It was their responsibility to check the price tag before buying a home that was too expensive for them.
With investing, the cycle heavily influences the price of any asset, just like it affects home values. It’s not just about picking a great stock, bonds or fund, it’s about also checking the overall cycle.
In general, the number of years in the current cycle can be a clue to whether or not an investment may be overvalued. You can also get a vague idea of how long it might be before the cycle changes by considering time frame and valuations. It’s a sort of like buying cashmere on clearance in the spring, but with less consistent, and much longer seasons. Nevertheless, you know that sale is coming, you just don’t know exactly when. For example, if the stock market has been in an up cycle for 7 years, there is a stronger probability that it will go down within the next year or two than if the market is in year two of the up cycle. Note: it feels much scarier in year 2 since everyone has the down cycle fresh on their mind. This is what leads investors to buy high and sell low.
For every investment guru that says you should ignore cycles, another guru says you should capture them. There are valid points for both, but no one can argue that capturing trends enhances wealth accumulation. Checking where an investment is in the cycle is like checking the price tag before buying anything; it makes good sense. Here’s the thing: Putting all of your savings into the stock market 7 years into a bull market without understanding this, just because you’ve decided to begin investing, or you’ve inherited wealth, is probably not the smartest investment strategy.
As Baron Rothschild said “buy when there’s blood in the streets”. The times I have done this have been my smartest investments, but it has been one of the hardest things I have done, and I have missed many a bottom. I strive for buying somewhere near the bottom, and selling somewhere near the top, as my dad used to teach me.
One of the gifts of age is that you get wiser with each cycle that you witness and experience. Live and learn. Warren Buffett said “The lower stocks go, the more I buy.”
There is no clear answer. The only guidance I offer is this
- Remember that market bottoms give you the opportunity to invest in the same asset at much cheaper prices but everyone is afraid (or it wouldn’t be cheap!)
- Consider market cycles in your investments, including home purchases and sales
- Check the cycle before buying an investment
- Try to have investments that move opposite one another when the economy tanks (although most assets move in the same direction)
- Know that the emotions of fear and greed naturally try to overtake logic near cycle tops and bottoms
While most financial gurus promote ignoring cycles, the best investors have made investments when they’re cheap. Often, they’re cheap because they were purchased near the bottom of the cycle.
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 s
#5: Kind of Investment…
You already know about the reason you own an investment from the R in your BRICKS, which leads to the kind of investments you’ll own. What kind of investments are you in? What kinds of investments are possible for you based on your current net worth?
Again, most people think of the stock market when it comes to investing, but investing can include many kinds of assets, such as stocks, bonds of all types, real estate and commodities, as well as alternative investments. If you are invested with a financial advisor or in a balanced fund, you are almost certainly already in several different kinds of traditional investments.
The important thing about having different kinds of investments is that it allows you to be diversified. In financial lingo, this is called Asset Allocation which simply puts certain percentages of your money into different types of investments, such as stocks and bonds. The amount of your money in each type of investment is determined based on your goals and risk tolerance.
A traditional Asset Allocation is like this:
- Stocks – S&P 500 Index 50%
- Bonds – 10 Year Treasury 30%
- Cash – Money Market 20%
A slightly more sophisticated Asset Allocation would be something like this:
- S&P 500 25%
- International 15%
- Commodities 10%
- Short Term 5%
- 20 Year 10%
- Global Closed End 10%
- TIPS 5%
- Cash 10%
In reality, real estate would also very likely be part of an overall Asset Allocation since most investors own a home. This is where your knowledge and skills come in. Most financial advisors focus on traditional assets only. You may also want to consider rental properties or small business as part of your Asset Allocation.
I include my home as part of my asset allocation, and suggest you do the same. Homes are the biggest investment most people make. Some financial gurus say that homes are not investments because they have expenses. This is true, but so do stock and bond investing. They usually have fees, commissions and taxes. Just like traditional investment, homes can also create wealth when bought low and sold high, especially given the huge tax advantage for capital gains when your residence is sold.
Many savvy investors now own investment real estate or their own small business, too. These are considered alternative investments.
If you own real estate in your home, then you may want to consider avoiding traditional investing in real estate through REIT’s since you’re already in the real estate market. This all ties back to your Big Picture explained in the first Brick. Every investment, both traditional and alternative, is part of a whole.
You can stop here, but if you have accumulated wealth, or tax deferred accounts, you’ll want to read about Strategy. Taxes are the largest expense for most investors, and what you have after taxes and fees is what you can invest to grow to fund your lifestyle and future.
One brick does not make a foundation. What’s your strategy to create, accumulate and retain wealth? All three elements are important.
Your strategy will vary based on your net worth, age and situation. It can include any of the following areas below, which are all straight forward. You could quickly look at the list to see which areas apply, or explore one area each month. For now, just choose your very next step to explore.
- Are your investments in the most tax efficient accounts? For example, are your income producing investments in a tax deferred account if you don’t need that income right now? Do you have the right kind of IRA?
- Is your retirement account efficient in terms of performance, costs and taxes?
- Should you invest in your own skills or business right now to create income streams doing work you enjoy? Sometimes this is the best investment since increasing income increases wealth accumulation and standard of living. A small business can also lower your taxes since our government legitimately has favorable tax treatment encouraging small business development. (This isn’t a trick. It’s legit.) All it takes to start a consulting business is a $25 investment in some business cards that state the benefit others can get from your expertise. Almost everyone has marketable skills!
- Are you taking advantage of real estate and other cycles?
- Have you considered real estate rentals as a cash flow investment with potential long term appreciation, and tax advantages?
- Is wealth protection in place? Have you taken care of the legal aspects of your life and your estate?
- What types of insurance do you need?
Reaching Your Goals
Look at that overall big picture 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.
Again, as you can see, none of this is rocket science. Most of it is common sense, so there’s simply no reason to feel intimidated about investing if you know the information here.
Having money to invest is a privilege. With privilege comes responsibility. Step up to the plate with confidence and knowledge to gracefully manage this privilege.
The bottom line is that your income and your investments determine the quality of your life, both now and later. Why not create wealth to secure a nice lifestyle for you and your family? Quality of life is just too precious not to do this.
Just remember, investing is shopping. You are using your money to get something based on the results it will deliver. It’s your job to make sure that it does because no one cares about your money more than you do. These are the basics that every investor must know…whether you invest yourself or work with a financial advisor.