Your Money, Many Choices
All of the financial advice in the world proposes to tell you what you should and should not do with your hard earned dollars. You get facts and figures thrown your way and the author’s interpretation of what that means for your money.
What if these decisions are more personal than that?
Anyone can look at a prospectus and see how a fund has performed, or look at a chart to see what a stock has done, but how do these things apply to our lives as a whole?
We are investing with a purpose, and knowing the facts is essential. I propose that investing is a personal choice of tolerance, knowledge, and time frame.
Once you have determined these traits for yourself, you can find the best investment for you, whether that is stocks, bonds, or index funds.
What are they?
Let’s take a quick look at what the different asset classes are and how we can invest in them.
Stocks- are shares in a business or entity that you are purchasing ownership in. One share is a fraction of that company’s entire worth. If the company becomes more valuable, then demand for the shares will drive the price of that fraction up.
Bonds- are shares of a business or entity’s debt that pays interest over time. Essentially, you are investing in the company with the company’s intent to pay you back with interest. Companies issue bonds for fundraising purposes and have to report this debt to their shareholders.
Index funds– are a collection of stocks, bonds, or even both. This collection of assets follows an index as closely as possible and is usually very hands off. This means that no one actively picks and chooses what is in this collection.
Mutual Funds- are also a collection of assets(stocks, bonds), but these collections are usually actively managed by human beings. They may follow an index, or follow investing strategies, or even just stick to a particular sector(i.e Technology). Mutual funds have a much higher cost than index funds due to the management involved.
Exchange Traded Funds– are also a collection of assets(stocks, bonds), but the method in which the collection is traded is different. These collections are sold as individual stocks on the open market. This means that they can be very liquid and be sold just like a normal stock.
Now that we know what we can invest in, or the vehicle that we are investing in, we should look at what our goals are.
Earlier we dreamt of life without bosses, managing our own business, or benefiting from the labors that led to passive income. It’s wonderful to get to these dreams, but where in the hell does your money go before you get there?
A savings or checking account is not enough. Your money will lose value sitting in one of these accounts and by the time you retire, inflation will have eaten away at it.
That means you need a higher return that can combat inflation. This is where everyone gives their opinion on what you should do:
- Real Estate
- ETF’s (Exchange Traded Funds)
- Their Business
- Oceanfront property in Arizona
If you’ve done any research into investing, there are plenty of opinions on where your money should be.
What we want you to accomplish are the goals you set forth for yourself. Sounds simple, right?
It can be made more complicated, but investing is about goals.
I promise you there will be people that tell you that you are missing out on something bigger, but I truly believe that investing is about self-control and not chasing the latest thing.
Put your goals down on paper or on a spreadsheet to find out what kind of money you want or need in the future.
Investing is about longer-term goals, don’t invest money that you will need this year. Think years into the future and determine what those goals are.
Some sample goals to think about are:
- Buying a home
- Having children
- Funding a child’s education
- Further investment in your own endeavors
You better not be looking at me crazy for the charity one. Giving can be very rewarding, and if you truly have more than you could ever spend, it can do wonders for your heart to give.
Now that we have our goals in mind, we have to ask the question of where to put the copious amounts of cash our side hustles bring in!
Under the Mattress
Kidding! Don’t put your money under the mattress. This is the moment when you have to look at yourself in the mirror and truly determine what you are comfortable putting money into.
If it is individual stocks, are you comfortable with your life savings being in one stock? Or three? That is a lot of risks.
If it is Index funds, are comfortable limiting your returns to how the overall market performs? Index funds also have a bit of cost associated with them, usually .05% or less yearly, but a cost nonetheless.
I’m purposely leaving out real estate due to the illiquidity of the asset. It’s just too hard to use real estate as a savings mechanism. It is a business venture in my eyes.
You can also reinvest in your growing business. This is ideal when first starting out, but for the sake of our current discussion, we have to find somewhere to put the excess cash.
Ultimately, we are going to put our money into stocks, bonds, or funds(index, mutual). Even if we boil down all the forms of investment into these three choices, people can and do still become confused with all the options.
It gets easier if you know your goals and timeframe, but should you maximize returns or keep your money as safe as possible?
Welcome to the question investors have asked since the beginning of time.
Long Term, Always
Now that we have established that we should be looking long term for these investments… wait, have we established why they should be long term?
Why do we recommend that you only invest for periods longer than a year?
First, in the U.S. there are major tax implications to trading a stock within a year. These rules also apply to real estate as well. When you trade a stock within a year of purchase, you will most likely pay your full income tax rate for any gains on that stock.
For example: If you are in the 25% tax bracket and sell a stock with a 10% gain, 25% of that gain goes directly to Uncle Sam. If you hold the security for longer than a year, you will be taxed at the lower capital gains rate.
Secondly, short timeframes for investing don’t allow for losses. Even if you had an amazing run and gained 10% in 6 months, you could lose 20% in the course of a day or two. It could take the market a long time to recoup those losses and you start to gain again.
Taking a little of the second point and adding to the third, being a short term investor means that you have to “time the market.” This means that you are trying to pick the perfect time to buy and sell securities or funds. While not impossible, it is a very difficult thing to do.
As you can see, we want to keep our investing goals far enough into the future to extract as much as we can from our investment and allow for compounding as well.
The best investors in history, have always been the most patient.
How to Pick
We have goals and some rules to follow when looking at time frames, but what actual securities or funds do we pick. Again we get into an area where there are more opinions than pure advice. There are many different strategies of investing and types of securities to invest in. Without going to deep into them here is a sample of some investing strategies:
Growth- is a concept of finding stocks that are already growing or have accelerated growth, and buying to ride the “wave”.
Value- is a concept of finding “undervalued” stocks and purchasing while they are “on sale”.
Broad Diversification- includes investing in mutual funds, index funds, and large collections of securities. Basically means spread your money across many investments to minimize risk.
Sector- is investing in a specific set of companies within a sector of the market. This would include technology, utilities, or consumer goods.
Our first two strategies above involve trying to time the market and find the best time to put your money into stocks or bonds. For the general investor, this is generally a bad idea. No one knows where the market will go next, but a lot of experts will try and sell you on some “hot” stock tip.
If you intend on buying individual securities, try to buy them over time and not in huge chunks. This will give you an advantage of dollar cost averaging.
Dollar cost averaging just means that your money is spread out over time and different prices on the securities you buy. This means that over time your money is “diversified” within an individual stock or bond.
So What Should You Do?
For long term, relatively consistent, and mostly safe returns, we would recommend that you place the large majority of your investment stash into index funds. The S&P 500 tracks the largest 500 stocks on the NYSE, and the large majority of funds have a hard time coming close to, much less beating its performance over time.
This doesn’t mean it’s right for everyone, but that is the purpose of this post. We want to identify what kind of investor you are and your tolerance to investing risk.
By placing your money in an index fund, you are diversifying across a large swath of stocks, which should minimize the risk of loss. Think of it this way, one company can fail and go out of business, rendering their stock worthless. What are the chances of 500 companies simultaneously collapsing and folding?
This takes the pressure off of you and keeps your funds safe.
However, investing still has risks, because the market does take huge swings up or down. Imagine you are close to your retirement dollar amount goal and then the market takes a plunge by 20%.
Funds in your account: $1,000,000
Funds in your account after a market correction of 20%: $800,000.
Oof. It could take years for you to see that account surge back to where it was before the market drop.
Most financial advisers will tell you to change the percentage of money that you have in stocks as you get closer to retirement age. They will advise you, wisely, to put a much larger percentage of your money into bonds or fixed interest securities. These will not follow the stock market and will hopefully provide a secure stream of income off of your accumulated funds.
Here are some examples of interest-bearing securities:
Bonds- are issued by companies to fund operations.
Annuities– are issued by insurance companies and are usually insured to be risk-free.
Municipal Bonds- are issued by local and state governments to fund operations.
By increasing your percentage of money in these as you get closer to retirement, you help to minimize the risk of market loss.
Funds in your account: $1,000,000
Amount in Stocks: $400,000
Amount in Bonds: $600,000
Funds in your account after market correction of 20%: $920,000.
We can live with that!
While some investors want to protect their money while using the power of compounding, other investors love the thrill of investing and want to “maximize their return”.
These investors are chasing those winning stocks that can go up thousands of percent over time. It isn’t easy to predict these outcomes, but there are large quantities of investors and firms that try to do just that.
It comes back to your tolerance as an investor and your goals. There isn’t anything particularly wrong about investing in this fashion, it’s just that it is dangerous and can amount to gambling if you don’t understand what you are doing.
Taking your life savings and investing into one or two companies, especially on a “tip” or with the expectation of high returns, is dangerous.
If you are this investor and need the ability to pick your own stocks, do so with a percentage of your overall money.
We call this a “Fun Fund” and it lets you explore those opportunities without risking everything.
It is true that it will minimize the humongous return possibilities, it also minimizes the risk of a stock going to zero.
The way we do this is by allocating 20% of our M1 Finance account to picking individual stocks. This is an amount that we can be comfortable “playing” with.
This approach isn’t for everyone. If you want to “set it and forget it”, we would not recommend this strategy.
But if you need the ability to find winning individual stocks, or to experience the adrenaline the market can provide, then this is for you.
Follow Your Heart
Investing is not just cold, hard numbers. Your psyche will play a huge role in what you decide to do next.
You have to listen to what your mind and heart tell you. If you have the tolerance for individual stock picking, then allocate some funds to that.
But if you simply cannot, then index funds will work diligently to make your money grow over time with a hands-off approach.
Add money consistently and with enough time your money will grow and outstrip inflation.
I wish there were a way to give you personalized advice, but we could never do that on this platform.
We recommend you read and research as much as humanly possible before reaching out to any professional help. That professional help could cost you large sums of money in the long run.
The psychology of investing is very real, and hopefully, we have given you some pointers on how to avoid investing mistakes.
We have to take some responsibility for our money. It is very easy to pick a fund and just send money there until you retire, but did you look at all the options?
Did you see what that fund costs you every year?
Is the fund diversified?
Is the fund aligned with your goals?
We have to find these answers, and we will follow this post up with more on the topic of where your money should go.
Make the choices that are right for you, but don’t do so blindly. Hopefully, we have given you some ammunition to take into your research and come out a winner.
How do you see your investments? Do you have a large tolerance for risk? As always we would love to hear from you!
Don’t forget to check out our full review of M1 Finance here.