Trader Network Co

Beginners Guide to Investing

“It’s not how much money you make, but how much money you keep, how hard it works for you and how many generations you keep it for”- Robert Kiyosaki
Investing in its simple terms is saving and deploying money in assets that will earn us a benefit in the form of income or price appreciation in the future. Without getting too technical, we invest our money today in the anticipation that it will grow multiple times in the future and at the same time give us a periodic income allowing us to retire comfortably.

Why do we need to invest?

We invest not only to achieve our financial goals but also to beat inflation. Inflation is the rise in prices in the economy over a period of time. It is essential for growth but we want it to be steady and not ravaging. Nonetheless, inflation erodes the value of money. The value you can buy with the same amount goes on decreasing each year. For e.g. movie tickets which used to cost less than $5 in late 90s now cost upward of $10. Gas which used to come for less than a dollar a gallon now comes for $3. However the median salary has only gone up from $54,621 in 1990 to $68,703 in 2020, a very marginal increase as compared to the doubling everything else has seen. Since the value of your money erodes each year, you want your income to increase by more than the erosion and investing is the only thing that will help. It will be especially helpful once you retire and there is no active income. Without a sufficiently large investment, there will be no retirement and one will have to work their whole life. Not a future that anyone dreams of right?

To invest successful, the first thing that one needs to do is invest in assets only and steer clear of liabilities.

Let us get a clear distinction of assets and liabilities as people tend to use the word investing quite liberally when describing expenses that they have incurred. Assets are those that generate value in the future in the form of periodic income or capital appreciation. Liabilities on the other hand are those that cost you money. They do not generate any returns, in fact they suck at your money causing you to have less than you had before. They also tend to have shorter life spans requiring constant money flow to replenish them.

Apply the distinction of assets and liabilities in real life:

Your money in a bank will be an asset as bank will pay interest to you or your father purchasing a second home and giving it out to rent in which case the second home will be an asset generating rental income. The second house may also increase in value in the future enabling you to sell it for more than what it was bought for.

A car is a liability. So are all the latest electronic gadgets. The more expensive the purchase, the higher the liability. A durable car worth few thousand dollars will have less expenses associated with it as compared to a fancy one worth hundreds of thousands. So next time you hear someone say that they have invested in a car, smile and nod and walk away to laugh at your leisure because they are sure going to lose money on it.

Here, we would like to clarify that we are not discouraging anyone to not purchase a car or gadgets. A car and an internet connected device is as much a bare necessity today as is food and shelter. However that does not mean one cant be smart about it. A new car loses a significant portion of its value once it is driven out of the car dealership. Try and look for used vehicles having run a few thousand miles. You will find plenty and they will work just as fine as the new one but will come at probably half the cost or if you are good at negotiations, even less. The trick is to pay as less as you can for liabilities so that their impact is minimum.

Now that we are clear on assets vs liabilities, let us have a look at a few asset classes that are available to us.

Equities

Equity or stocks/shares as they are popularly known as are documents signifying ownership of companies. While we will go into depth to explain equities in our subsequent posts, for now it is enough to know that investing in stocks of various companies allows you to be owners and participate in the growth and profits of those companies. Lot of the popular companies you see around for e.g. Coca Cola, Google, Amazon, Apple etc. have their shares publicly available for purchase. If you had invested $10,000 in Apple when it first became available to the public, it would be worth $6.7 million USD in 2019 beating all inflation numbers and making you pretty rich. Take that inflation. More wondrously, had you invested $1,000 in Coca Cola in 2009, it would be worth $2,800 at the start of 2019 ensuring that the doubling of price in coca cola did not affect you at all.

To invest in equities, one needs a broker who will deal with the various intermediaries to get you the shares. One has to open a brokerage account with a trusted and reliable broker who will then take care of your funds and shares, transact in them for you and provide you with valuable advice. There are hundreds of brokers in USA today with reputed legacies like Charles Schwab, Fidelity Investments to up and coming brokers with tons of advanced features yet just as reliable like TD Ameritrade, E Trade etc. Go ahead, open an account with TD Ameritrade or E Trade (Hyperlink their names), we will wait for you to come back

Getting started with Equities:

There are numerous businesses around us. We can spot the successes and failures of businesses around us quite easily as compared to all those experts we see on TV. Gap stores have huge crowds and fresh stock is coming in daily, wonderful. The restaurants of Wendy are empty even on weekends? Not good. Take a look around, spot successful businesses and brands, chances are they will be available for you to purchase an ownership stake in. Gap, McDonalds, Procter & Gamble etc. are all available and one just needs a brokerage account to own them

Debt

Debt as we know is the borrowing and lending of money. We all have lent to and borrowed from our friends and family during the course of life and while not everybody has returned our money (let that be a lesson in life to never lend to friends), overall we have had a decent experience. Lending money to government and corporates however is a pretty decent investment and unlike our friends who take our money for free, here the borrowers will pay us back a little bit more in the form of interest. Investing in debt is lending your money to an institution like a bank, the government or corporates who will then pay you periodic interest which will be a percentage of the lent money and return the entire borrowed amount.

Like shares represent ownership of a company, there needs to be a document that represents ownership of the debt and that document is called a bond. Any borrower looking to borrow money will issue bonds with a certain value called face value which the lender will then pay to acquire. The bond will have a maturity date and the periodicity with which interest payment will be made. That interest payment is called coupon payment. For e.g. say company XYZ wishes to borrow $1 million. They will issue 1,000 bonds with face value of $1,000. An investor looking to invest $10,000 will simply purchase 10 of these bonds and become the debt holder of the company. The company has declared that it will pay a 5% coupon on face value and pay it semiannually with maturity being 10 years. It means that the company will pay $25 twice a year per bond and at the end of 10 years will return all the money. We shall go into detail about bonds and types of bonds as well as the origins of the term coupon payment in subsequent blog posts. (For those who love to google and are curious regarding the origin of the term coupon for bonds, here is a hint: Google coupon bond of 1898 Hessler and click on images. The picture will tell you everything). Bonds can be purchased via the same route as equities i.e. via brokers. They can also be purchased from various banks that offer them. Some of the banks include Bank of America, HSBC, TD Ameritrade, E Trade etc.

Getting Started with Debt:

The Government is the largest borrower around as well as the most trusted. One can always rely on government paying you back. Hence their bonds are considered risk free bonds. You can invest for a wide variety of periods from 91 days to 30 years. For those who like to earn more than a bank account and at the same time do not want to risk their money can opt for these bonds. Those who are willing to take small risk for slightly larger returns can prefer corporate bonds. Go ahead, open an account with TD Ameritrade or E Trade and purchase some bonds. We will be waiting for you.

Real Estate

Real Estate is a collective term used to refer to physical properties along with all the resources in it. For e.g. when someone purchases a land, they also own the mineral and crop resources that come with it as well as any buildings on it. Now here an important distinction must be made. Owning a house where you live cannot be considered an asset. While it costs a hefty amount and it appreciates in value when you go to sell it, you don’t earn any income on it. That being said, real estate has had its fairs of praise and criticism and has seen particularly bad times after the 2008 financial crisis but remains a crowd favorite after gold. Land like gold has had an ancestral attraction to us albeit for different reasons. Those that have held land have benefited from its resources as well as the power it brings and none can attest to it more than the oil barons from Texas. That attraction for land and property persists today with house flipping being a popular investment strategy for those with access to money.

Access to real estate has always been limited to those with means due to the high capital requirement in purchasing land and properties. It has since been democratized by the introduction of Real Estate Investment Trusts or REITs as they are called. REITs function like companies and they can issue units which work just like equity. But whereas in equity, shares represent ownership of companies, in REITs units represent ownership of property. So a REIT will collect small amounts from thousands of investors, issue units to them and use the collected money to purchase property which it will then lease out. The rental income from that lease will be distributed to unit holders. This has made it possible for anyone to own real estate and it forms a powerful investment choice. Some well-known REITs include Public Storage, Equinix, and Welltower etc. We shall discuss about real estate in subsequent blogs.

Getting started with Real Estate:

For most of us, REITs are the only way to go. They are a good way to go and build a significant investment in real estate which can then be withdrawn to purchase an actual property.

Cash

As much as it strikes people, cash is also an asset. While it might or might not earn interest on it, cash remains an asset by the virtue of emergency value it brings. It is readily acceptable and widely acceptable and can be used or obtained instantaneously. Investment in cash is done to keep an emergency backup which will be useful while you liquidate other investments. Also during particularly bad times, when everything is losing value, cash will sustain and serve well.

One can store cash in banks via savings accounts, fixed deposits or Certificate of deposits where it will earn some nominal interest. One can also store cash at home but it won’t earn that interest. Several countries also run Postal savings system where Post offices will accept deposits and offer slightly higher rates of interest than banks. USA had a postal savings system which was discontinued in 1967. Alternatively cash can also be stored in extremely short term government bonds like the US Treasury paper.

 

Portfolio Construction

Now that we have had a chance to look at various assets, how do we go about deciding where to invest? Each asset class has its own advantages and disadvantages over others and it is not recommended to stick to just one asset class. The below picture will allow for a better explanation

As one can see, no single asset class has done well consistently. Across the board each asset class has topped in some years and bottomed in others. There has been a year when even cash has done better than everyone. This just highlights the benefit of investing in all asset classes over a single one. The term used is diversification. The collection of investments in various asset classes is known as a portfolio.

Getting started with a portfolio:

While we shall learn more about portfolio design, creation and maintaining an optimal portfolio to achieve one’s financial goals in subsequent posts, a good way to start is to divide the portfolio into five parts. Cash is the first line of defense for emergency expenses and at least a year worth of expenses must be held in cash. It can be safe to start with 5-10% of portfolio in cash and divide the rest based on risk tolerance and exposure. For e.g. a young investor with a steady job can invest as follows:

Equities hold a higher risk and a young investor can bear that and thus has a higher allocation to equities which will allow for good growth of his/her investments. An older retired person will have a different allocation which is as follows:

An old investor will have more debt and less of risky assets like equities since they need a steady income and preserve their capital which can be done with debt but at the same time have some equity that will allow them to keep pace with inflation.

The importance of investing and having assets that generate income was never more stressed than during the pandemic where people lost their jobs, homes and had to struggle for food. A similar situation awaits those that do not save for the future after the retirement. As the median life expectancy increases from 63 years in 1945 to 78.6 years in 2017, a larger income will be needed to take care of medical and lifestyle expenses after retirement. It is also imperative to protect your portfolio from inflation. People often start investing late, in their 30s and 40s and that is not enough by the time they retire at 60. This has led people to continue working in their 70s and 80s when they should be enjoying time with their spouse and grandchildren. The insistence on an early start to investing is due to the magical wonder called compounding.

Compound interest is where your interest earns interest. For e.g. if you invested $100 in a bond that paid 10% coupon. At the end of the first year you would receive that $10 coupon and together you would have $110. Now if you were to invest that $110 again into the bond, you would now make $11 next year. This is compounding. The exponential factor here is time and more than the selection of where to invest, it is the time you stay invested that matters.

Let us do a quick study. Let us consider three people A, B and C who each begin their investment journey at different ages. We assume they all retire at 60 years of age and they all earn the same rate of return (11%). A begins at 18 years of age, B at 25 years and C at 30 years of age.

As one can see, just a 5 year gap can mean such a huge difference in the final amount earned by A vs B and a 12 year gap throws C out of the race altogether.

I leave you with this wisdom: While we all wish we started early, allowing us to retire early, it is still not too late. Start your investment journey today and allow us to be your partner on this. It is a journey fraught with perils and challenges and you will find us a reliable partner as we guide you in achieving your financial goals, recommending products, services, tools and players who will be beneficial and warning against those that will be detrimental. So come join us as we strive to unlock the mysteries of finance and become wealthy on our own terms.