Am I Saving Or Investing?
What is investing?
When is parting with your money investing and when is it just spending? Investing is the act of committing money to something with the expectation of getting additional income or profit. It is the process of laying out money now to receive more money in the future.
It’s about setting priorities for your money because spending is easy and gives you instant gratification, but investing is hard because you have to wait for a hopeful and uncertain reward.
In this way, investing requires prioritizing your financial future over your present desires. It’s a way of setting aside money while you’re busy with life and expecting that money to work for you so you can reap the rewards in the future.
There are many ways to invest. You can start your own business. You can educate yourself. You can buy stock in another business. You can buy a bond to lend money to a company or government. You can buy real estate. All have positives and negatives and understanding this and how different investments work is critical to your success.
For example, what does a mutual fund invest in and how do the managers decide? What is a credit rating and who decides the rating? What are the penalties for accessing my money?
While there are no guarantees when investing, some work gaining an understanding of investments can increase your odds of success.
No one approach fits all investors. Everyone has different reasons to invest, goals, time frames, comfort levels, time and interest to be involved directly.
Setting your goals or objectives is simple in concept because your basic options are:
Safety of principal
Growth
Income
Decide on your goal before you invest. Assign a weighting to the above 3 categories if you want it all. Articulate why you are investing rather than spending your money and articulate the end result you’re seeking. Goals cannot be created in a vacuum; you also need to articulate your comfort with risk and your time horizon.
Risk tolerance can be expressed simply as your ability and willingness to risk losing money. How much of a market drop can you take? When do you need your money – do you have a lot of time to recoup a major loss in value? Investments should be aligned with the time horizon you need your money especially if it is a specific and important goal.
Be honest with yourself about your knowledge of and comfort with investment products. Some investments require sophisticated specialist knowledge and others you can Set and Forget. Investments should be based on comfort level and willingness to devote time to research and monitor. It is important to acknowledge that we don’t usually know what it is that we do not know – think about what you do and do not know to the extent you can. BUT do not let a lack of knowledge stop you from learning – that would be like saying you’re too dirty to take a shower! If you don’t know enough, then learn!
Technology has changed investing with a profound impact. There’s been downward pressure on fees, better access to speedy information. Online discount brokerages are readily available to you, affordable and easy to use. Innovative ‘Robo-Advisors’ are worth your attention too: firms construct and manage portfolios using algorithms and usually index funds. You have all the tools you need to be a successful DIY investor – you just need a process to follow and a good understanding of the fundamentals of investing.
The ABCDs of Investment Success:
Ambitions: you are clear and appropriate with your investing ambitions
Balance: you have a suitable balance of diversified assets
Cost: you are minimizing all your costs
Discipline: you maintain perspective as a disciplined investor
Your first step is to write an Investment Policy Statement, which is simply a basic framework for your investment plan:
Objective: Maybe it’s something like growth of a certain percent each year so that you can go to Harvard for a graduate degree
Constraints: Set your time horizon here for the window that you’d ideally like to take two years off and go your Harvard degree – this timeline will guide your thinking in terms of how much volatility risk you can tolerate here
Saving target: Commit to the amount and timing that you’ll be reasonably able to add to this investing account such as $2000 monthly with intention to increase by $500/month through gradually living more frugally
Asset allocation: The mix of stocks and bonds will be based on your target growth rate but tempered by the timing that you want to spend your money on Harvard tuition
Rebalance annually with discipline, which means the painful and uncertain exercise of selling some of your winners and buying more of some of your losers
Monitor annually and make sure you’re on track to meet your objective or assess if you need to adjust your risk profile and hence mix of stocks and bonds, your saving vs spending lifestyle, timing of when you’ll go to Harvard, if inflation has changed tuition expenses, and your expectations in general
Most investment objectives are straightforward: save for retirement, preserve assets for financial security, fund education; specific goals like these.
But constraints might be complex and also more difficult to state. Importantly, risk and return are related where the desire for greater return will require taking on greater exposure to market risk.
Usually the investment time horizon is another key constraint. For example, an endowment with infinite horizon might take some risks that would be unwise for investor looking to fund a child’s education in the near future. Other constraints can include exposure to taxes, liquidity requirements, ethical investment considerations. Because some constraints may change over time, they should be closely monitored.
Without an investment plan/policy, people tend to build portfolio from the bottom up, focusing on investment products piecemeal rather than how the portfolio as a whole is serving the objective.
For example, you might mistakenly just collect funds, often without thinking about how they fit with your overall allocation. While paying close attention to each investment may seem logical, the process can lead to a hodgepodge of holdings that does not serve your needs, may end up concentrated in a few sectors rather than give you broad exposure to global markets.
A thoughtful Investment Policy Statement guides you through a process where you start by defining your objective clearly, taking a level-headed look at the means of getting there and then creating a detailed and specific plan.
Being realistic is essential to this process, which just means recognizing your constraints and understanding the level of risk you are able and willing to accept. Then you’ll make sure your asset allocation is suitable for your portfolio’s objective.
Both asset allocation and diversification are rooted in idea of balance. Since all investments involve risk, you can manage the balance between risk and potential reward through choice of portfolio holdings.
Premises of this philosophy:
A diversified portfolio’s proportion of stocks, bonds and other investment types determine most of its return as well as volatility
Attempting to escape volatility and near-term losses by minimizing stock investments can expose you to other types of risk including the risk of failing to outpace inflation
Realistic return assumptions are essential to choosing allocation
Winners and losers among market sectors and geographies change constantly and rapidly, so diversification and discipline will help you mitigate loss and participate in gains
You may feel like you have a lot to learn, but you’re making great progress and you’re in the right place. Just keep learning, don’t get discouraged, but keep an eye on your over-confidence.
