What you will learn inPart 1

What is investing and why do we do it?

• Investing is laying out money now to receive more back in the future.

• We invest for several reasons.

• Retirement

• Sending kids to college

• Saving for a house or car

• For fun or speculation

Before

Write down why you are investing

Why is this important?

Compounding!!!

Investing is a marathon, not a sprint. Having a why will keep you on track when you are tempted to take money out of your account to buy something you don't need.

What is compounding and why it's important?

Compounding is this:

• Beginning of year 1, you invest $10,000 and earn 10%.

 

End of year 1, you have $11,000 ($10,000* .10 = $1,000).

 

• Beginning of year 2, you invest $11,000 and earn 10%.

 

End of year 2, you now have $12,100 ($11,000* .10 = $1,100).

 

In other words, your money earns money, year after year, as long as you keep your money invested.

 

The above is a simplified example. Investing is never in a straight line. Gains and losses tend to come in bunches.

Let's look at two scenarios

The most important factor in compounding is time. Let's walk through two scenarios. (Warren & Charlie)

The only difference between the two is time. In scenario 2 (Charlie), the compounding process starts 10 years later at age 35.

Warren

Initial investment-$10,000

Contribution amount-$200/month

Years of compounding-40 years(starts at age 25)

Return-8%

Charlie

Initial investment-$10,000

Contribution amount-$200/month

Years of compounding-30 years(starts at age 35)

Return-8%

Warren

We're going to run these two examples through a compound calculator to see how much money each will have at age 65.

Compound Interest Calculator Example 1

Warren's results

Compound Interest Calculator Example 1 results

At age 65, Warren will have $838,980.

Charlie

Compound Interest Calculator Example 2

Charlie's results

Compound Interest Calculator Example 2 results

At age 65, Charlie will have $372,506.

The main takeway...

From the two scenarios, you can see how ten extra years affects the final result.

 

Ten years doesn't seem like a big difference, but 10 more years of compounding yields an extra $466,474 in your bank account.

 

Which is a life-changing amount for most people.

Having proper expectations

David Rock, the director of the NeuroLeadership Institute, says there is a physiological reason we are disappointed when life does not meet our expectations.

The neurotransmitter dopamine is released in our brain — and makes us feel good — when something positive happens.

He added:

When we don’t hit our expectations, our brain doesn’t just get slightly unhappy, it sends out a message of danger or threat. That suggests that the cliché “hope for the best but expect the worst” has a lot of truth.

In investing, having proper expectations is important because your expectations will determine how you allocate you investing dollars.

What are reasonable expectations for investing in the stock market?

10%

According to most sources, the stock market has averaged 10% from 1924-2014. Nearly half the gains resulted from dividends.

Adjusted for inflation, the average return has been 7%.

Returns in any given year are volatile. (See below)

Stock market returns

In addition...

The returns we care about are real returns. There are two types of returns.

  1. Nominal-The stated rate of return.
  2. Real-The return after taking into account inflation.

For example:

 

If your portfolio returned 10% in 2017 and the inflation rate was 3%. Your nominal return was 10% and your real return was 7% (10%-3%).

A real world example:

From 1966 until 1982 the S&P 500 earned a respectable 6.8% in nominal returns

 

However,

 

During this time period, inflation averaged  6.8%. Making real returns from stocks a break-even trade over 17 years. 

 

What's even worse is real returns for bonds during that same 17 year period was -40%.

 

That's why it's important to think about real returns, not just nominal returns.

Active vs passive management

What's the goal ofactive management?

• The goal of active management is to achieve alpha or "beat the market".

• Active management is when other people pick your investments; such as mutual funds, hedge funds, or smart beta ETFs.

• In addition, you can do your own research and choose investments for yourself.

What's the goal ofpassive management?

• The goal of passive management is to earn the market return of an index such as the S& 500.

For example:

• If the S&P 500 returns 10% for 2018, your return would be 10% minus the cost of owning that fund.

• Vanguard's S&P 500 ETF (VOO) charges 0.04% or 4 basis points. You're charged 4 cents for every $100 invested.

• With this approach, you want to be well diversified and seek out investments with the lowest costs.

So... Should you pick active or passive?

The research states that most active managers fail to beat a low-cost index fund.

From the report above:

Over the 15-year period ending Dec. 2016, 92.15% of large-cap, 95.4% of mid-cap, and 93.21% of small-cap managers failed to beat their benchmark.

In addition, your ability to pick which managers will outperform in advance will prove challenging.

My opinion...

Why not do both?

Have a percentage of your money in low-cost, passive products and use what's left to take aggressive risks. Whether that's in stocks, real estate, angel investing, or a private business.

Looking for help in managing your money

The resources below will give you a good start.

Betterment

Our approach to long-term investing can help you earn 2.66% more per year than a typical investor. Our technology helps make this possible by lowering taxes, lowering fees, diversifying your portfolio, and enabling better investor behavior.

 

Wealthfront

Manage your risk

Your investments should reflect the risk you’re willing to take. We’ll create a diversified portfolio and keep it balanced for your risk tolerance.

 

Nerd Wallet

If you would like to hire a financial advisor, NerdWallet has a great guide on what you should look for and how to pick one.

 

Looking to pick your own investments?

These websites will come in handy when doing research on potential investments.

Morningstar

A great website to research potential investments. They offer research for stocks, bonds, mutual funds, and ETFs.

 

Angel List Syndicates

For accredited investors only.

Want to invest in startups? Experienced angel investors will invest in companies that most people don't have access to on your behalf.

This is high risk investing, but also high reward. I recommend reading the book "Angel" by Jason Calacanis before you start this type of investing.

 

True Alpha

We help investors and traders discover investing ideas. We express our ideas through stocks and ETFs with specific targets designed to maximize our upside and limit our downside.

 

In part two, We'll show you how to open an investment account (coming soon)