For me, success in investing boils down to two things: 1) buy a diversified portfolio of great assets, and 2) be patient. The first item sounds more complex, but patience is often the harder of the two.
To start with, let’s think of “investing” as putting your money to work, in the hopes of earning a return on it. Investing could be viewed as a subset of money you are “saving”, which we can think of as setting money aside for a future purpose. Saving can include stuffing money into a mattress; if you’re not spending it now, putting it aside in the mattress does technically count as saving it. However, it’s not exactly safe in the mattress, and it’s certainly not likely to increase in value while in the mattress either. Instead of stuffing $1,000 into a mattress, let’s start our discussion with an example of why we would stuff our $1,000 into some investments instead.
A pair of twins are 30 years old, and both have $1,000. Twin A sticks his money into a mattress, while Twin B invests her money in the stock market. Twenty years later, when the twins turn 50, Twin A pulls his money out of the mattress, counts it and confirms he still has $1,000. Twin B checks her investments and thanks to an average annual return of 5%, now has $2,600 in her account. At this point, Twin A decides to invest his money and Twin B also leaves her money invested. After another twenty years, on their 70th birthday, Twin A sees that his investment has grown to $2,600 but is chagrined to see that Twin B now has over $7,000 in her account – all from the original $1,000. This example is only an illustration of how investing can help grow your wealth; performance isn’t guaranteed and investments can lose money, but over long time periods we can make some reasonable planning assumptions. So, we invest because it gives us a reasonable hope that when we pull our money back out, it’ll be worth more than what went in.
One of the key considerations when investing is risk. At its most basic level, risk is the reason to invest – uncertainty regarding business outcomes is why investors expect to be rewarded for putting their money to work. Put differently, high-risk investments often have a wider range of potential outcomes – that is, there is the possibility of a very high return, which compensates for the possibility of a massive loss or any result in between. On the other hand, low-risk investments usually don’t have a large upside. However, not all high-risk investments are worth it; chasing high returns on an asset without solid intrinsic value has led many to disaster in the past, and will do so in the future. Each individual has a unique outlook on, and experience with, the risk/reward relationship, which results in different tolerances for risk when investing. An individual investor’s risk tolerance is something I absolutely take into account when determining the right mix of assets for them to invest in.
There are many different reasons why you may choose to invest your hard-earned money; being able to retire comfortably and paying for college tuition are two of the more common ones. Whatever your goals are, they are the starting point for any decisions when it comes to your investments. The time horizon for your goal is an important consideration because while we can make some reasonable assumptions about average returns over long periods of time, if your time horizon is short, then it may not be enough time to recover from a sudden drop in the market. For example, if you want to buy a house in 2 years, and already have the amount that you want to use as a down payment, then choosing a very low-risk option makes the most sense so that you can make that down payment when the time comes. In contrast, investing money for retirement when you’re 35 has a long enough time horizon that you can take on a bit more risk and ride out some ups and downs of the business cycle.
Once we know what your goals are and what your risk tolerance is, we will work to build a portfolio of investments that support achieving your goals. There are many different investment vehicles out there, including stocks, bonds, real estate, commodities, and many more, as well as derivatives that are based on the value of those underlying assets. In the interests of keeping this section short, the key concept to keep in mind is this: your portfolio is a set of many different assets, and what those assets actually are, plus how they are weighted, is what determines the growth and resilience of your investments.
I tend to take a long-term approach to investing, so long as that aligns with the time horizon of your goals. For example, when putting your money to work in preparation for retirement, I want to buy and hold high-quality assets, and avoid panicking during market downturns, or getting irrationally exuberant during bull markets. However, a long-term view does not equate to being passive for passive’s sake. If the underlying value of an asset has disintegrated, or the management of a mutual fund has swung from solid fundamentals to wild speculation, then it likely makes sense to reevaluate our choice of investment vehicle. Given this long-term view, I’m less concerned about what a particular stock or index did on any given day – trying to predict and/or react to short-term swings in the market can result in bad decisions that undermine long-term performance.
With all of that groundwork laid, I know you’re still wondering what it is I actually do for you. (Obligatory John C. McGinley video clip) Once we’ve established your financial goals (including their time horizons), I will put together an investment portfolio for you, and help you put it into action. If you have retirement accounts, those can – and often should – be left where they are, and I will help you make the necessary trades through that custodian. If you don’t have an account, or if it makes sense for you to move an account, we can set up an account where I can make trades on your behalf (with your approval, of course). Based on where you have investment and/or retirement accounts, your set of available investment options is often unique, and my job is to evaluate what is available to you and develop the best portfolio within those constraints. Once we’ve designed and implemented your portfolio and set up any ongoing purchase allocations, I will continue to monitor the portfolio weights, their underlying value, your time horizons, and the vehicles (mutual funds, etc) we’re using in order to recommend changes as they become necessary.
For those that want to do some more reading on the topics discussed above, please take a look at these links. These are but a few of the many great resources out there, so this list doesn’t cover every key topic, nor does it reference every good site. If you want more, follow me on Twitter @tomfiggatt. Additionally, it should be noted that I don’t necessarily agree completely with everything said in every article, nor am I endorsing or vouching for the content of others’ sites.
1. Around investments, the term “risk” tends to be used as shorthand for volatility, or how wildly the value of something changes. I tend to look at risk a bit differently, and Morgan Housel does a great job articulating his Alternative Definitions of Risk.
2. For a more traditional take on defining risk, check out The Balance on Understanding Risk.
3. Joshua Kennon on how “the market” doesn’t actually exist, so Pay Attention to the Weightings of Your Individual Holdings When Constructing a Portfolio.
4. Farnam Street’s Rules of the Road for investing.