How To Invest Money
- Real Vision
- January 18, 2022
- 3:42 PM
Why invest? Why not save?
There is a saying by Dave Ramsey: “You must gain control over your money or the lack of it will forever control you.” Learning to steward your money is the first step to take control over your life. Learning how to invest your money is the first step to build wealth. And the good news is: investing money has never been easier and can be done with any amount of money.
In today’s economy where savings accounts yield close to zero interest, asset prices surge, central banks create money on unprecedented levels and inflation rates are picking up, simply depositing money on a savings account has become a fairly unattractive option. In the current market conditions, savers are losers. Due to the newly created money entering circulation, the buying power of a single dollar is steadily declining.
In this video, Raoul Pal explains that in the current market environment cash has to generate a 15%-25% yearly return just to keep its buying power. Such returns are only possible, if money is put to work in investments. Money left in bank accounts is steadily decreasing in value. The new form of savings accounts are therefore diversified portfolios of “safe assets”. Think of these portfolios as savings accounts with much higher interest rates.
Further, understanding the magic of compound interest is a mighty weapon in today’s financial system and a strong motivator for investing. Investing a steady amount over a long period of time leads to exponential growth of the invested capital thanks to the effect of compounded interest. A person investing $100 every month for 40 years, generating 10% annually, will have accumulated over $500’000 on an investment of only $48,000. Warren Buffet said: “No one wants to get rich slowly”, but using the compound interest effect is definitely a great way to do so.
Exercise Caution
Investing can be risky. Therefore, the number one rule is to never invest more than you can afford to lose. Further, before you put any hard-earned cash into an investment vehicle, make sure to do your own research. The internet is full of quick-money schemes and so-called financial experts which are more than willing to sell you mediocre advice through workshops, books or tutorial videos. Usually, too good to be true returns are exactly that: too good to be true.
The best way to start investing is through mainstream investments (e.g. stocks) on a small scale. Learn, observe, adjust. Get a feeling for the market and for your emotional resilience to market movements. Often, one’s emotions are the largest stumbling block on the way to stable returns. Timing the market is hard to impossible, so it may be best to not even try it.
Diversification is key for successful investing. Don’t put all eggs in one basket and don’t fall for the temptation to put all your money into one investment in the hope that this one move will make you rich quickly. Investing is neither gambling nor entering the lottery. Diversify your investments among different asset classes (stocks, bonds, commodities, forex, crypto) to reduce risk.
Usually, the higher the returns, the higher the risk and vice versa. A health risk assessment and the awareness of potential losses is key for successful long term investing. An often used way to manage risk are stop losses. They sell your positions at a predetermined price level (e.g. -20% of purchasing price), thereby reducing losses and preventing total wipeouts.
Key considerations
There is no one-size-fits-all investment solution. The best way to invest your money is whichever way works best for you. To figure that out, you will want to consider:
- Age: No one is too young or too old to start investing. Investing is the best financial education you can get. Depending on your age and stage in life, you will have different goals, different time preferences and different ways you prefer to access the financial markets.
- Goals: Identify your goals for investing. Would you like to retire early? Are you investing to afford real estate? A short-term goal? A long-term goal? Or do you want to invest just for fun? Identifying your goals will help you to sketch a roadmap on how to get there.
- Time: What is your time horizon? Raoul Pal has said that the best piece of advice he ever received was from Paul Tudor Jones who said, “your trade’s time horizon has to match your idea’s time horizon.” Your goals determine your time horizon, which in turn determines the appropriate investments. To find trades matching your time horizons, see how-to-think-about-time-horizons.
- Budget: What is your budget for investing? Is it a one time investment or a monthly amount? Most investments have very low or no minimum amount requirements. Exemptions are certain funds or structured products, which require minimum buy-ins.
- Risk Tolerance: How much financial risk are you willing to take? Not all investments are successful and financial markets can be volatile. Risk is often correlated to returns. It is important to find a balance between maximizing your returns and the risk level you are comfortable with. Longer time horizons usually allow for more risk taking, as market shocks can be sat out.
- Involvement: Would you like to be actively involved in investment decisions and market research, trying to find the next hidden gems yourself and timing the market just right? Or do you neither have time nor desire to make investment decisions and want to follow a more hands-off, predictable and stable approach? Today’s financial markets offer convenient solutions for both active and passive investors.
- Tax: Some forms of investing are subsidized through tax benefits. This mostly goes for retirement accounts, which are tax-exempt but subject to withdrawal limitation. For starters, it can be beneficial to first consider these types of investments. Depending on your jurisdiction, investment options for such accounts can be restrictive.
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What to invest in
To start investing, you need a basic understanding of the different asset classes available in the financial markets.
Stocks
The classic. When buying stock, investors acquire a part of a company. Usually this comes with certain rights, such as voting rights and the right to possible dividend payouts. The Stock market is one of the central pillars of the financial system and it is therefore crucial to understand its basic operation principles. Investing in the stock market is simple for retail investors nowadays, thanks to smartphone apps, which allow for the purchase of stocks at the touch of your fingers.
To follow the overall stock market performance of a country, an industry or even the world, there exist multiple indices. One of the most followed stock indices is the S&P 500, which shows the combined performance of the top 500 US companies. Other important indices include MSCI World (1600 companies worldwide), Nasdaq Composite (3000 technologie companies) or the Euro Stoxx 50 (50 largest companies in the € area).
Read the guide: How Does The Stock Market Work?
Read the guide: How To Invest In Stocks
Bonds
Bonds are financial instruments companies use to raise debt capital. It is a contract between investors and the company, stating how much money the investors lent to the company, the yearly interest rate the company is paying to the investor and the date the company has to pay the capital back to the investor. Bonds generate yield, but also fluctuate in price, depending on current interest rate levels and a company’s probability for default.
Read the guide: How To Invest In Bonds
ETFs
ETF stands for exchange traded funds. A fund is a basket of shares, usually with a common theme. The most common themes are indices (S&P 500), countries (Top 50 German companies) or asset classes (Real Estate World). ETFs are passively managed, usually following an index, which allows for low fees. Thanks to their diversifying character, their liquidity (exchange traded) and the low fees, ETFs have become widely popular investment vehicles.
Read the guide: How To Invest In ETFs
Index Funds & Mutual Funds
An Index Funds is a vehicle that tracks a market index (e.g. S&P 500). It invests in all the financial instruments that the index represents. An Index Fund manager’s job is to ensure that the fund performs the same as the index.
A Mutual Funds is a pool of capital collected from many investors to invest in financial instruments. These funds are operated by professional money managers who attempt to earn profit according to the objectives stated in the prospectus. Due to the active portfolio management, these funds usually have higher management fees than ETFs.
Read the guide: How To Invest In Index Funds
Read the guide: How To Invest In Mutual Funds
Real Estate
Building a diversified real estate portfolio requires large amounts of capital and knowledge, which may exceed a single investor’s means. A solution offer real estate funds and real-estate-investment-trusts (Reits). They allow for worldwide real estate investments with a minimum investment of often lower than $1,000 USD.
Read the guide: How To Invest In Real Estate
Cryptocurrency
Crypto assets are booming and keep making headlines. They have developed into an asset class of their own. To participate in the crypto markets, usually an account with a crypto exchange such as Binance, Coinbase or Kraken is required. More and more traditional brokers and trading apps are starting to offer trading in the top cryptocurrencies, such as Bitcoin, Ethereum and Cardano, as well.
Read the guide: How To Invest In Cryptocurrencies
Commodities
Commodities is a generic term for raw materials, oil and agricultural products such as coffee, corn or wheat. All of these products are traded on financial markets. Even though they can be traded by anyone, in depth knowledge of the respective commodity is necessary to trade them successfully. Commodities are often traded through Futures and Forward contracts, which allow investors to agree on a price today for a delivery date in the future.
Read the guide: How To Invest In Commodities
Forex (FX)
FX is short for foreign exchange trading, which is the purchase and sale of currencies. The FX market is the largest financial market in the world, and therefore of great importance to the financial system. It has its own set of rules and is largely uncorrelated to the stock and bond market. To learn about the basics of FX trading, check out the following guide.
Read the guide: How To Trade Forex
Derivatives
Derivatives are financial instruments whose value depends on the price movements of an underlying asset. They allow for leverage trading, hedging and shorting. The most common derivatives instruments are options and futures.
Read the guide: How To Trade Options
Read the guide: How to Trade Futures
How to start investing
Now let’s get started with investing. To gain access to the financial markets, we have to go through brokers, robo advisors, financial advisors or other financial services.
Stock Brokers: Stock brokers are the intermediaries between an investor and a securities exchange. Because securities exchanges only accept orders from members of that exchange. Individual traders and investors are reliant on the service of an exchange member. Brokers provide that service and are compensated through trading fees, commissions and other means.
Most banks provide their customers with access to the financial markets. For smaller investors, their fees can be hefty though. It therefore makes sense to choose a broker with low or no fees, such as Fidelity, Robinhood and Schwabb. They have simple user interfaces and provide access to the most common financial instruments such as stocks, bonds and ETFs. Also, many brokers let you buy fractions of shares, which allows the diversification of smaller portfolios as well.
Robo Advisor: Instead of trading yourself, you have the option to outsource investing to a Robo Advisor. Robo Advisors take care of your investment in an objective and automated way based on algorithms. They take the hassle out of investing by trading for you, while still being cheaper than traditional asset managers. Many Fintech companies and large brokers offer Robo Advisory services to their customers. Do your own research to find and choose a Robo Advisor you would like to work with.
Robo Advisors determine the appropriate investment strategy by asking for your risk tolerance and investing preferences. Some also let you set goals (retirement with 50) or choose investment themes (emerging markets, sustainable investing). Once the Robo-Advisor is customized to your liking, you can let it start investing and trading for you. But be aware, even though these algorithms are tested, there is no absolute guarantee that they work flawlessly, especially in turbulent market conditions. You may want to test the Robo Advisor with only a part of your funds first, before entrusting it with all your investments.
Financial Advisor: A financial advisor is your financial planning partner. If you want to reach certain financial goals in life, like early retirement, sending your children to a prestigious university or buying your dream home, a financial advisor will help you draw a roadmap to accomplish your goals. In the process, the advisor will discuss many topics with you, especially in areas involving money. Together, you will determine the amount of money you should save, the types of investments you could make, what kind of insurance you need and how you can optimize your taxes.
A financial advisor is also an educator. He should be able to teach you about budgeting, saving, tax planning, retirement planning, insurance and basic investing principles, all according to your current financial situation and phase in life. Depending on your level of financial knowledge and expertise, it can make sense to talk to a financial planner to set your life on a financially solid path.
DIY Investing: Unlike previous generations, retail investors today have access to in-depth financial knowledge and data. Thanks to technological developments, tools once reserved for professionals are now easily accessible by everyone. Technical financial knowledge is available for free on video streaming platforms, educational services like RealVision explain the complex world of finance and crypto and real market data is provided free of charge by broker apps. On social media platforms like Reddit and Twitter, users share high quality financial content with their communities open for everyone.
These new opportunities empower people to take their financial education into their own hands and learn how to invest themselves. Be it learning how to invest in stocks online, shorting the US-Treasury market or participating in crypto projects, knowledge and tools are abundantly available on the internet for every topic imaginable. The knowledge growth of retail investors is a highly positive development, but we also advise caution. As much as the internet is a treasure of knowledge, it is also of misinformation. Do your own research, double check facts and obtain information from multiple sources.
Quick Recap
Investing is no longer only for the financially educated, but is available to anyone. In recent years, many platforms have been created that provide simplified access to the financial markets for retail investors. In the current low interest environment it is all the more important to make use of that access. Solid investments allow you to offset the deprecation of cash and to participate in the asset inflation happening around the world. If you are new to investing, start with little money to get a feel for the financial markets and consider consulting a financial advisor. And most importantly: start taking control over your money today so that the lack of it doesn’t forever control you.
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