Investing has been a popular term since the beginning of industrial revolution. Starting from May 2017, I started to actively invest my money. I have faced with successes and failures. I have learnt many valuable lessons through this experience, which I think could help a lot of people to gain a better understanding of the investment arena.
I will be writing several blog posts over the next few months. In this post, I would like to start by sharing reasons to invest and what are some of the investment options available.
This seems to be a stupid question, right? The goal of investing is to make money, no? In my opinion, the goal of investing is to grow your money at a managed-risk fashion. If you plan to make lots of money through investing, you will also be exposing yourself to losing a lot.
The key to making better investment is to manage risk and that means doing research and cutting losses when things does not go the way you expect it to go. The famous book recommended by Warren Buffet “The Intelligent Investor” points out that: The goal of investing is to first preserve capital, then grow it. We will touch upon risk management later in another blog post.
So, if the goal of investing is to first preserve capital followed by growing it, then why not just save money in a high interest saving account? Well, the reason is inflation grows faster than the interest rate that banks offer. Banks can offer interest rate because they take our money to invest elsewhere and only share a small portion of it with us as interest. Saving money in a high interest saving account is basically slowing down the decay of your purchasing power. Of course, when I say purchasing power, I mean purchasing of house, luxury goods, your children’s education and all those expensive stuffs. Your purchasing power against replenishable commodities will most likely rise over time thanks to advancement in technology that makes replenishable commodities cheaper in the long run (assuming population grows at a slower rate than technology advancement).
In short, if you only rely on a savings account to grow your money, you will lose purchasing power or wealth over time. This is something you definitely want to avoid. It is the core reason why you should find some good investments with reasonable risk.
What to invest?
So, what are some of the investment options? There are many options in this world that you can invest in. Some of them are: stock, bonds, commodities, foreign currency, cryptocurrency, startups, real estate and much more. We will go through the more popular ones to gain a better understanding.
Small business and physical real estates are investments that require some form of cash plus additional work. If you are starting your own startup or small business, you are likely going to need to invest your own money in it plus you are going to put in a lot of hard work. Furthermore, the success rate of new businesses is slim. Unless you are passionate about something, starting a business is probably not the right route for you. One of Elon Musk favorite ways to describe the startup experience is — “Starting a company is like eating glass and staring into the abyss.”
What about real estates? From some of my previous family experiences, real estate investing is not a guaranteed success too. I have seen my parents managing their additional real-estate properties, and it is not helping our family to grow any money. The way that you can really make money with real estate is to speculate that the value of a particular property would go up. This is generally true but the return discounting the effort you have to put into it may not be worth it. In where I lived (Toronto), this is true for the past 5 years. However, data suggests that the environment is quickly changing.
The next type of investment is the big, red, hot cryptocurrency. I think it is wise to stay away from it until its value flattens out. There is no currency in the world that keeps growing. As of now, the whole crypto thing is a scam. You cannot really buy much using it, which begs the question — what is it good for? This is why Google banned their ads. This is why Warren Buffet advises people to stay away from it. The belief of cryptocurrency can keep rising is a complete BS but I don’t have time to argue why that is the case.
Foreign exchange/currency (Forex) is always an alternative investment. Forex is actually not too bad as an investment. One can use the difference between interest rate growth between 2 countries to speculate the direction of the Forex pairs. There is only one small little problem. The Forex broker allows investors to use extremely high leverage. Leverage is a mechanism to amplify gain and loss. If you invest in Forex, avoid leverage and you should be good.
Next up, commodities. In general, replenishable commodities will always decay in value in the long run. This is because technology like biotech and automation will drive down the cost to produce them. Unless you know how to short replenishable commodities, it is probably not a good idea to touch them. Oil is special because it is a controlled non-replenishable commodity. Basically, the price is based on the supplier policy, i.e. OPEC. Lastly, there are metals. Gold is actually very special. It is actually very much influenced by the local currency. This correlation is due to the purchasing power of the currency. A weaker currency means less purchasing power, which means inflation. Gold is highly dependent on inflation. Other metals is a combination of inflation plus supply-and-demand. For example, lithium is highly driven by demand due to electric vehicle. In general, I am not against investing in commodities. The only thing to note is that commodities tend to swing wild and one has to understand the supply-and-demand of the commodity to be successful.
Then, there are bonds, which are essentially an IOU (I Owe You) contracts. Bond gives you fixed frequency payments and the value of the contract can change. Investing in bonds is often seen as a very safe thing to do. The safest of them all is the US government bond. If you are looking for a safe investment, bond is usually the right thing for you. However, please expect that the return of bonds isn’t large. If you get 6% annual return, that is considered to be really good. On average, the return is around 4.7% for the past 12 years.
Finally, there are stocks. Stock is basically a piece of paper stating that you own a piece of a company. Sometimes, stock will payout quarterly dividends. Typically, you can expect stocks’ value to grow by a lot if you hold it for a long time. However, stock prices do fluctuate quite a bit. And from my experience, some of these fluctuations cannot be comprehend so easily. This is why the behavioral economists argue that market is not always efficient and they could act irrationally. This is probably something that scares off most people to invest (but I think it is still better than Bitcoin).
Luckily, thanks to advancement in financial engineering, there exist Mutual Funds and Exchange Traded Funds (ETFs) that help you own stocks with less fluctuation. Both mutual funds and ETFs are financial instruments (basically a piece paper) proving that you own shares in a pool of money that owns something else. ETFs and mutual funds can contain any instruments that we talked about earlier — real estate, cryptocurrency, commodities, bonds and stocks.
So, how can ETF or mutual funds lower the risk of owning stock? The solution is to buy a bunch of different stocks in well designed quantities. Good portfolio managers will use modern portfolio theory to maximize the ratio of return divided by volatility (price fluctuation). It basically uses the law of averaging to minimize risk. It is simple yet powerful.
Now that you know a few asset classes, I hope you are asking the following question — what are some good investment?
If you are a beginner, I highly recommend buying the SP500 index fund like SPY. In fact, I believe everyone should have at least 70% of excess money (money that they don’t need in the next 6 months) holding an index fund like SPY. SPY’s average return over 20 years is around 10% annually assuming you never touch it.
So, how much can you make with 10% annual interest? Let’s do some math. It depends on how much money you plan to save. Let’s assume you stay invested in SPY 30 years and you invest $2000 every quarter. After 30 years, you will end up with almost $1.5 million. Index funds are extremely powerful investment vehicle. Calculations are based on this online compound interest calculator:
However, I would not recommend investing now (June 2018). A recession or a bear market seems to be inching closer. If you buy it at the top, it can take 3 or 4 years before the value bounces back to its original level.
Is there any safe long-term investment for now? Quite frankly, I have not found any great opportunities yet in 2018. Gold is probably the only exception. But, I have some slight concerns over it for the next 3 months. Nonetheless, I do believe that they are safer than bond and stocks for the next 2 years. I will leave this reasoning for another time.
This concludes my blog post on reasons to invest and some of the investment options available. In my next blog post, I will be writing about the risks and reward of investing in other securities other than index funds or bonds. If you have any questions or comments, please feel free to let me know. Hope you find this post useful!