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investing 101 intro to investing

Investing 101: An Introduction To Simple Investing

You need to invest your money. It simply doesn’t make sense not to. Even if you only invest 5% of your money, it would still be worth it.

This is your investing 101 cheat sheet. We explain the basics of simple investing, and aim instill the proper mindset you need to succeed.

You understand that investing is smart and that a lot of people have made a lot of money doing it. The problem is, you never took an investing 101 class, you’re scared to lose all of your money and you don’t want to do the work.

Good news is, we’re about to tell you that all of your concerns are bullshit.

You can understand investing, and if you read this whole guide, you’ll have the basics you need to get started. You don’t need to be scared to lose all of your money if you look long term and follow The Average Investor’s Commandments (see our infographic).

You also don’t have to do all the work, nor do you have to give away all of your gains to avoid doing the work. You’ll be relying on automation and letting the computer do the work for you.

After you read this guide, the only thing left for you to do will be to take action. Don’t worry, we’ll guide you through the process in the following articles of our investing series. Enough chit chat, lets get started.

We also discuss this on the show:

What Does Investing Mean and Why You Should Care

Investing, at its heart, is the trading of your money today for a lot more money in the future.

The investing we talk about revolves around the stock market. That said, putting your money into a business you create, or a home you will live in, can also be considered an investment. Investments by definition are high yield over the long term. Operative word being long term.

There are people who are afraid of the market – something we will address later in this article. One common approach of these people who fear the market is that they put the majority of their money into a combination of checking and savings accounts. I’m sorry but the joke’s on them.

As it turns out, just like how banks like to sneak fees on you, they also don’t like to give away their money. That mindset is reflected in the interest rates of checking and savings accounts.

When you deposit your money in the bank, the bank turns around and invests that money at 7% a year or more. After they collect their profit they give a tiny shaving of it to you. But wait, that’s your money they are investing, you deserve a bigger cut!

The only way to combat the bank taking advantage of you is to just invest yourself.

Question is, why invest?

investing-101-savings-checkings-investments

The illustration above shows a $1,000 investment over 30 years and compares it to what you would earn with a checking account and what you would earn with a savings account. With an investment account on average you can expect to earn over 19,700% more as compared to a checking account.

Interestingly, over 30 years you can only expect to gain roughly $175.80 with a checking account and $281.89 with a savings account – a difference that is pretty meaningless when you look at it over such a long time period. Especially when you would gain over $6,000 if you had just invested your money like we told you to.

That you would be crazy not to invest and you would be equally crazy to jockey your money between a checking and savings account as the difference is negligible. You’re better off keeping 90% of your money in a checking account and 10% in investments than 10% in a checking account and 90% in a savings account. Personally, I don’t even have a savings account as it just complicates my life.

The Meaning of Portfolio and Diversification

Whenever you read about investing you’re bound to hear the words Portfolio and Diversification.

What do they mean and why should you care?

investing-101-healthy-portfolio

In the above picture you can see a silhouette of you at the top of the tree. Everything you own is considered part of your portfolio. Your retirement accounts, your investment accounts, even your home. What you don’t see in this image is a checking account, savings account or debt. Why? Because none of those are investments, they are all short term assets. Your portfolio reflects your long term wealth building strategy – not the short term.

You’ll notice that we describe four general types of investment assets: Stocks, Stock Funds, Bonds, and Bond Funds.

Sure there are many more investment mixes but we didn’t want to distract from the ultimate point of the illustration. To convey what diversification looks like.

Diversification is, at its simplest, a way to describe owning multiple types of investment assets. To go a bit further, diversification describes a whole slew of investment categories.

For example, one of the biggest investments people make in their lifetimes is purchasing a home. However, a home is but a single piece of property with a very specific geographic location in a single city/town. This could be considered very risky because what if the area floods or becomes less popular or the home collapses. The best way to account for these scenarios is not to worry yourself sick but to diversify.

This means contributing to a tax advantaged account like a 401k and IRA. These accounts will both save you money now and earn you awesome returns in the future.

How can we know you’ll get awesome returns?

We know because they are accounts which are locked down forcing you to invest in the very long term. We’ll go into more depth on this long term investing idea in the next section.

You’ll also notice that we have Betterment and Brokerage as types of accounts on that list. We list Betterment because it’s the single best and cheapest way to invest automatically in the market average – something we’re obsessed with.

As for the Brokerage account, this is your playground if you choose to play.

In your Brokerage account you can take risks on companies like Apple or Tesla or invest in high performing Mutual Funds or ETFs that we discuss on the blog. Why do this? Maybe because you’re interested and want to see if your gut instincts can help build you wealth faster. This is something we encourage but only under the umbrella of diversification. See, on the illustration above, the brokerage account amounts to at most 1/5th of your overall portfolio.

Diversification is smart because you both protect yourself from failure and position yourself to take advantage of multiple robust methods for building wealth. To not diversify is just stupid.

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The Triumph of the Average Investor

The beauty of the market is that it’s anything if not consistent. When you ignore the things the media blows out of proportion on a daily basis, the movement of the market can really be explained by its three base components. Productivity growth, the short term debt cycle and the long term debt cycle.

investing-101-productivity-debt-cycles

Productivity Growth

This is equivalent to technology getting better, faster and us constantly learning from our mistakes. We will always be able to do more with less time and resources than we were able to in the past. That is productivity growth in a nutshell.

Short Term Debt Cycle

This cycle is defined by a growth period and then a recession period. These cycles last about 5 – 8 years and should explain why you always feel like the market is booming and busting (because it is). The short term debt cycle peaks when loans become more expensive (interest rates go up).

Following the bust, rates reset at a nice low level to start the cycle over again. What causes the short term debt cycle bust? It’s caused by when the payments of debt in the market exceed the income in the market. This leads to a recession, otherwise known as negative growth.

Long Term Debt Cycle

This is similar to the short term debt cycle only much bigger and it takes much longer to play out – typically 50 years. Consider September 2008 before Lehman’s collapse as the peak of the long term debt cycle. The long term debt cycle peaks when the economy is saturated in debt and it literally can not take on any more. This causes massive deleveraging, a process where the large amounts of debt unwind although not without a lot of lenders losing a lot of their money.

Why are we telling you all of this?

We’re telling you this because it’s important to understand that the market works in cycles. It will constantly go up and down, up and down. Once you know and understand the market you can stop fearing it and start using it to your advantage.

The one truth is that in the long term, productivity will go up so over the long term so will the stock market. This graph is on a roughly 100 year scale. It’s easy to understand all zoomed out but when you’re in the thick of it, it’s hard to see where you are in the cycle. Don’t worry, all you need to do is hold on long term and you will do just fine.

Now, that’s a lot of information and we didn’t even mention The Average Investor and what that means.

The Average Investor is someone like me or you who doesn’t try and time the market – buy low and sell high. What’s the point? It’s going up over the long term and who has time to obsessively check stock prices?

Not only does The Average Investor not try and time the market but they also don’t try to beat the market. They just try and achieve average returns. Luckily for The Average Investor, the market average is conservatively at 7% (10% on the high end).

To see what that means just refer to the first graph in this article. It says that if you invest a certain amount of money for 30 years, at the end of the term you should expect it to be more than 7 times larger than your initial investment. Translation: Average is pretty damn good.

Basically, being an Average Investor is a great goal because it doesn’t involve a lot of work or stress and locks in a nice healthy return over the long term. What more could you ask for?

We called this section The Triumph of the Average Investor because the majority of the big market winners in the end are playing the same long term strategy (including our hero, Warren Buffet). Why gamble all of your money in Wall Street’s casino when the goal is to grow your money, not lose it all?

Why You Should Never Use a Financial Advisor

Everyone wants to be the success story where only a handful of years investing results in a mountain of wealth. The truth is, that does not happen often and is very unlikely to happen to you.

That’s fine though because we know that over time and with enough patience we can easily find success. The problem is when people don’t have patience – they start to seek out shortcuts. One of the most common shortcuts we hear about is people about hiring a financial advisor.

There are plenty of reasons why you should’t hire a financial advisor – these are a few of our favorites:

1. Nobody Will Care About Your Money More Than You

Who do you think will work harder to build your wealth? Some person you just met or yourself? A financial advisor’s compensation is rarely if ever tied to your success. The majority of their income is based upon the amount they get you to invest so pony up and hope they care.

2. The Ability to Avoid Fees

If you wanted a single investment that has you covered from a performance and diversity standpoint you could always go with something like a Vanguard Lifecycle fund and pay as low as 0.15% in fees and that’s it. On a side note, we have a list of our favorite Vanguard funds that you should probably check out if you know what’s good for you.

If you go with a financial advisor you’ll still pay the Vanguard fee and then you’ll also pay a fee to the financial advisor. This graph below illustrates what 1% in fees look like over the course of your lifetime. That’s of course if you could ever be so lucky as to escape with only 1% in fees.

investing-101-401k-fees

3. You Might Not Get The Best Financial Advisor

Have you ever thought about why this person wants to be your financial advisor? You don’t have millions of dollars and you likely don’t have hundreds of thousands of dollars either. The advisors who are actually good get the big clients and the not so good ones are managing the the money of small fish like you. Interestingly, less than 25% of financial advisors can beat the market average (market indexes like the S&P500). Chances are, the financial advisor you pick will not be one of the top 25%.

Would you even be able to tell the difference between a good financial advisor if you had a chance to sit down and talk with 100 of them? Chances are you’ll go with the best salesmen.

Better you invest yourself than give your money to someone who doesn’t care and likely won’t beat the market either. The good news is that this is neither difficult nor time consuming because most of the time we’re just going to mirror the market average. No need to get fancy, plus we only invest long term.

The Average Investor’s Commandments – Investing 101

If a 7% return is average, then the average is pretty awesome. Fortune favors the bold.

  1. Think Long Term – When you look at investing on a personal scale, it’s very rare for a sudden move in price to mean very much. Unless something cataclysmic happens, things will balance out so be patient.
  2. Invest What You Can Afford – While you can always sell your investments, it would be better if you left them alone and let them grow. Invest as much as you can while reducing the chance you’ll need to sell your investments to cover basic expenses. The goal is to always keep a few months expenses around in case something happens and invest the rest.
  3. Buy What You Believe In – Don’t listen to the radio, don’t listen to a friend, listen to yourself. If you do not know or understand what you’re buying, don’t buy it. Even if you do understand it, only invest in something that you personally believe in.
  4. Do Your Own Research – Maybe you love bananas but if you don’t understand the banana business you either figure out how it works or don’t invest in it. Is the banana business profitable? Are they innovators or just people milking an existing product line? You get the point.
  5. Set It and Forget It – We’re not day traders here so we’re not going to try and be like them. We invest in the future and our style reflects that. The goal is to automate the investment process so you can spend your time living, not managing money.
  6. Consistently Contribute – The truth is, very few people can perfectly time the market and I’m sorry but you’re not one of them. That’s ok though because you can beat it with Dollar Cost Averaging. Contribute every month to your investments and it won’t matter if you buy at the peak or bottom of the market. He who can stay the course, wins.
  7. Be Fearful When Others Are Greedy – The first half of our favorite quote from Warren Buffet. When everyone is a winner you should be concerned. If you or your friends are making quite a lot of money very quickly with your investments, act very conservatively.
  8. Be Greedy When Others Are Fearful – The best time to buy is when the world is on fire. Don’t be delusional, be realistic. Are the fires real or just the typical knee jerk reaction of the media? We’re bargain hunters, not suckers.
  9. Find and Remove Frivolous Fees – Rule: A bank will always try to trick you into paying fees. Be vigilant and tireless when it comes to reducing your fees. When the stakes are highest, so are the fees. Even a 1% fee can become significant over the long term.
  10. Diversify – If it can fail, it will fail. That’s why we always plan ahead for failure. Diversification is your cheat code for riding the market. Invest in many different things so no single failure can ever shut you down.

average-investor-commandments-640x2364

Click image to view full infographic.

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Start Investing Simply

Get started with set-it-and-forget-it style investing. With Betterment you get world investing for a price that makes traditional investment advisors anxious.

They automatically diversify you across a whole set of investments based on your level of risk. The only decision you have to make is what level of risk you’re willing to take. It’s as easy as moving a slider from 0 to 100. High risk, high reward is 100% stocks and 0% is the conservative approach with all bonds.

While getting invested is important, understanding when and how you can retire is the goal. RetireGuide is a tool created by Betterment to help you determine exactly that. When you can retire and how much you can spend when you’re retired. The tool is incredibly detailed – we’ve explained it all in our extensive Betterment Review. Seeing is believing.

I’ve been using Betterment since 2012 to invest my emergency fund and I love the simplicity.

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  • http://www.simplemoneyconcept.com/ David @ Simple Money Concept

    Awesome! I like anything simple! Here are my two cents:
    1. Agree with you on how people have to invest for themselves. After all, nobody cares more about your money than yourself, except the people who are inheriting the money from you.
    2. Agree with you on your 7% average return. Although historically it’s been slightly higher, it’s a very good, realistic, and conservative expectation.
    3. Agree that average is pretty damn good!
    4. Somehow disagree on why you should never hire a financial advisor. If you are referring to sales people, then I absolutely agree. But investing is just one part of financial planning. There are other area they can give you advice on. Like risk management, estate planning, and etc.. I think it’s ok to use a financial advisor if you already have the basic financial education. If you know what you want, you are simply farming out the labor. As long as the fees are reasonable, I wouldn’t mind paying a fee for somebody else to do the actual execution.

    • http://www.listenmoneymatters.com/ Andrew Fiebert

      David, thanks for the thoughtful reply!

      We use 7% as you said, a conservative expectation. We’d rather people beat their goals than underperform : )

      Risk management is a fancy word for simple concepts like diversification and I think that concepts like this are both easy to understand and critical to the success of independent investors. It’s important to remember that we’re just people with rather simple financial situations, not investment banks that require multiple people to hold the role of “risk manager”. Also, if 2008 proved anything, it’s that “risk managers” aren’t really that good as the biggest risk in years just snuck up on them ;)

      My thoughts on estate planning are no different really. Once you peel back the fancy name you realize it’s just planning for retirement, reducing your tax bill and other core things that are widely covered by many financial bloggers.

      However, if you are a financial advisor these big words are important because they definitely scare quite a lot of people into paying for “risk management” and “estate planning”. If only they knew what they were really getting.

      • http://www.simplemoneyconcept.com/ David @ Simple Money Concept

        Hi Andrew,
        Again, I agree with you for the most part. I’m not trying to defend financial advisors. If you look beyond investing/retirement/diversification, there are complicated issues for some people.
        Risk management also includes finding and structuring the right insurance policy to protect yourself and your business.
        Estate planning also includes finding the best trust structure for you and your family.
        If you find a “good” financial advisor, my opinion is to use him/her if you do have complicated issues.

  • Grace Villafuerte

    Dude – Mind —> BLOWN!!!! I finally went to a Deferred Comp Asset Allocation workshop at work. I guess I’ve avoided it for various reasons, one of them being intimidated that I wouldn’t understand any of what they said. So – I was right on the one hand. A year ago, I would not have fully grasped the depth of the discussion. BUT today is a different day!!! Thanks to your podcast and website, I was shocked at what I understood (stocks, bonds, funds, asset allocation, etc) AND I even was able to ask intelligent questions regarding investing and hold a relevant conversation with the presenter!!! Firstly, THANK YOU for the fun ride! And secondly, thank you for making this higher/next level of personal finance understandable and attainable. (And THIS is why you should win at FinCon!)

    • http://www.listenmoneymatters.com/ Andrew Fiebert

      Hah! Yes! We aim no lower than to blow minds ;) I’m thrilled you were able to use what you’ve learned on the site and apply it to your money situation “in the real world”!

      I definitely encourage you to explore a bit more of the “Invest” section of the site, there’s quite a bit more there that should help in bringing you up to speed.

      As for FinCon, I hope we win too! I know you voted for us – thanks!!!

  • Richard Coy

    I’m getting a little overwhelmed by how many people are recommending Betterment. My wife has been using this and I think the service is horrible. The etf’s they choose are not very good. 90% stock has 37.6 in VEA and 10.6 in VWO, which are very unstable funds. If you want a very unsteady portfolio then chose them. If you want to win, use vanguard mutual funds 500 or Total Market. I would never recommend Betterment to anyone I like. I will write a more detailed post on this on my own Blog later this month when it is finished. – FinanceBard

    • http://www.listenmoneymatters.com/ Andrew Fiebert

      Richard, you’ve provided no actual reasoning behind your statement beyond “not very good” and “unstable”.

      Take a look at the charts for VEA and VWO:

      https://personal.vanguard.com/us/funds/snapshot?FundId=0936&FundIntExt=INT

      https://personal.vanguard.com/us/funds/snapshot?FundId=0964&FundIntExt=INT

      VEA and VWO are large holdings in a 90% stock Betterment portfolio because they are CORE components of a strong well diversified portfolio.

      VEA is comprised of medium and large sized US companies and VWO is emerging markets where quite a lot of growth will be found in times of economic expansion.

      Perhaps you should listen to our episodes where we interview Betterment’s CEO and head economist as questions very similar to this are addressed:
      http://www.listenmoneymatters.com/inside-betterment-with-jon-stein/
      http://www.listenmoneymatters.com/economics-101-opportunity-cost/

      • Richard Coy

        I’m listening right now thank you. The charts for those ETF’s show a very high volatility which I would say is unstable. The 10 year return also looks less promising than other stock etf’s. I’m understanding why those things are chosen after hearing the CEO speak. Maybe those are also chosen for more gain/loss harvesting. I wish betterment would have a much higher percent in VTI or options for adjusting without changing allocation. I still like the show and appreciate the links, even though betterment was not a good choice for us. – FInanceBard

        • http://www.listenmoneymatters.com/ Andrew Fiebert

          Richard, sure they are volatile in the short term – most things that trade on the stock market are.

          We say very frequently across many many episodes that we don’t consider people who put their money in the market for less than 2 years to be investors.

          Frequently we’ve discussed how statistically it’s highly unlikely that you can perform well in the market with any strategy other than a buy and hold approach over the long term. Reading your comments tells me that we certainly need to mention that stuff more frequently.

          Investors who look 3 years+ into the future would look at graphs and not even notice the little day to day volatility. Generally, movements like that are meaningless and create unnecessary drama as we don’t trade on that level.

          • Richard Coy

            “We say very frequently across many many episodes that we don’t consider people who put their money in the market for less than 2 years to be investors.” Me and my wife are for long term investing and a buy and hold. We plan on reaching Financial Independence in 8-10 years. The fact that I can read the facts of those two investments and not like them doesn’t make us not in it for the long term. Can I outperform the market with investments in Vanguard indexes and some stocks? Probably not. Can I outperform betterments 90/10 plan in a 10 year time frame? Most likely. In 15 years will they beat me? No one has a crystal ball for the market, even them. Choosing not to invest in something because you don’t like the allocation is much different than buying and selling often. It’s also better we pulled out of betterment early so we can buy and hold elsewhere.

          • Andrew M

            I’m curious to know what you might suggest that would be comparable to Betterment?