You have a good job. Or a job. Your fridge is stocked. You’re making good progress on your student loans. Now, to quote Liz Lemon in 30 Rock, it’s time to do “that thing that rich people do where they turn money into more money.”
You want to invest (or at least, you think you do), but you have some questions. Is investing gambling? What are the safest investments? Should I invest in stocks? What’s the best investment strategy?
Aaaah! Pressure. When you begin to start thinking about investing, you’re going to get a lot of bad information. Some people will tell you investing is dangerous, while other sources will try to push you toward buying the latest hot stocks. The amount of conflicting advice out there is staggering. That’s why we’ve put together this handy guide.
What Is A Good Investment? breaks down why you should be investing, the best investment strategy, plus the difference between investing and gambling.
If you have any questions at the end of this guide, you can email us personally: email@example.com
You can also skip around chapters:
Let’s get this show on the road!
Chapter One: What Is A Good Investment
Why do people invest? Sure, there are probably some people who watched The Wolf Of Wall Street and decided investing looked cool.
But the reason most people should be investing is because investing can be one of the most efficient and safest ways to grow your wealth.
What wealth?! you might be asking. That’s exactly why people invest. Investing is a way to take small sums of money and grow them over time. Investments are different from savings accounts in that they focus on growing your money as opposed to just saving it up.
So, what is a good investment?
There are lots of different ways to invest. You can buy a piece of real estate. You can lend money to your friend who’s opening up a craft brewery. You can play one of those claw games at the arcade where you put in a dollar and try to get a teddy bear.
All of these moves are technically “investments” – you’re putting in money hoping to get something out of it. But as you can see, not all of these investments are built equally. There are good investments and chump investments – so how do you distinguish between the two?
In our experience, the best investment strategy should have three quality traits:
Replicable – This investing method has worked in the past and will likely work again. Now, no investing method is 100% guaranteed. But if a replicable investing method had a resume, it would open with “proven track record of success.” Replicable investments are the safest investments.
Reasonable – This investing method doesn’t promise anything ridiculous, like how to double your money fast. If it sounds way too good to be to be true and isn’t being backed by multiple third party sources, then the investing method may not be reasonable.
Approachable – This is an investing method where you can get in on the action. You don’t have to already be a millionaire to begin using this investing method.
We’ll call this trifecta of traits RRA.
If you’re skeptical about investing, congratulations: you’re human! It’s good to be skeptical. But chances are, if you find an investing strategy that’s RRA, you’ll already know the answers to will questions like how do I know which stocks to buy? or what if there’s a stock market crash? Is investing gambling?
The investing method we recommend is to invest in the market through long-term passive investing. Passive investing, also known as “buy-and-hold” strategy, is where an investor focuses on building a financial portfolio that’s designed to withstand market volatility and focus on long-term success. Long-term means that instead of trying to time the market based on short-term price movements. you’re keeping your money invested in the market over a long period of time. Why? Because the market has historically shown to provide positive returns.
If that made your eyes glaze over, don’t worry. We’ll get more into that later. For now, it’s important to remember the following:
Investing is a way to grow your money. There are different investing methods, but the best investment strategy is replicable, reasonable, and approachable.
Chapter Two: The Best Investment Strategy
So, you now have your scam detecting goggles on. You’re ready to begin investing. So, let’s get specific.
In Chapter One, we mentioned the method of passive investing. What is passive investing, and why is it the best investment strategy?
When a lot of people begin investing, they ask questions like where should I invest my money? and which stocks are the hot stocks? These aren’t bad questions. If you’re investing the stock market, it would make sense to ask which stocks should I pick?
The answer? All of them. Sort of. We’ll explain.
The Problem With Hot Stocks
It’s extremely difficult – dare we say it, close to impossible – to predict which securities will be winners and which will be losers. This process of stock-picking has been repeatedly proven to not work. Why not? Simple: people are not magic. We can’t predict the future.
So let’s all throw in the towel, call it a day, and stuff our savings under our pillows. Huzzah!
Just kidding, of course! There is a way to invest without actively trying to predict the future. That’s where passive investing comes in.
Instead of relying on speculation and stock-picking, with passive investing, you create a financial portfolio designed to emulate an index (portion) of the market. Why would you want to do this?
Remember how we said the best investing strategy is replicable – able to be repeated over time? Passive investing gets a gold star in this category. Simply put, you want to copy the market because over time the market has always risen in value.
Now, that doesn’t mean there aren’t short-term fluctuations (this is called market volatility), but overall, the market has risen over the last 100 years. Yes, this even includes rough periods like the Great Depression and the 2008 credit crisis. That’s why you want a financial portfolio that mimics the market over the long term. As the market grows, so does your money.
Instead of scrambling to read the latest investment news and make daily trades, a passively invested portfolio employs a buy-and-hold approach. Once you have your portfolio, you stick to it (unless you need to rebalance – but we’ll get to that in Chapter Three). Hence the passive in passive investing.
Depending on your appetite for excitement, here’s where you might feel either relieved or disappointed. Passive investing isn’t very sexy. There’s no GET RICH QUICK tagline attached. But remember how we said a good investment strategy is reasonable? That’s where passive investing shines. Yes, passive investing can help you grow your money, but no, it won’t promise you anything too insane.
The insane promises (PENNY STOCKS THAT WILL EXPLOOOOODE) may seem sexier in the present, but can actually be incredibly risky. You know what will be really sexy in the future? Being able to quit your job and travel wherever you want. Taking that luxury workout class you always dreamed of. Never getting nervous about a bill ever again. And these dreams can be accomplished with a passively invested financial portfolio.
So, just how do you create a passively invested financial portfolio? Well, first we’ll back up a step and ask:
Just what is a financial portfolio?
Like any other portfolio, a financial portfolio shows off a collection. In the case of a financial portfolio, a collection of financial assets, like stocks and bonds. Some people might include their properties or other large assets in their financial portfolios. For simplicity’s sake, when we talk about financial portfolio that’s made up of securities – shares stocks, bonds, or REITs.
Chances are you’ve heard the term diversified portfolio, but what does that mean?
You know the expression don’t put all your eggs in one basket? That’s the whole idea behind diversification in investing. Let’s say that instead of passive investing, you decided to stock pick. You’ve heard good things about Tesla, so you buy 10 shares of TSLA. What would happen if TSLA went out of business? So would your portfolio, because TSLA was the only thing you had it in.
However, if your financial portfolio holds several different securities, you’re spreading out your investment risk.
How Can You Minimize Risk From Your Investments?
What is investment risk? Investment risk is exactly what it sounds like: the likelihood that an investment will lose money. The more securities your financial portfolio holds, the more diversified it becomes, and the more your risk is spread out.
Since a passively invested portfolio is designed to mimic the market, it holds a ton of securities.
Tons of securities = less concentration of risk in any given individual security. This minimizes your risk overall.
In the past, creating a substantially diversified portfolio was really expensive, because buying so many individual securities was pricey. Then along came the beautiful index fund.
An index fund holds a basket of securities. There are different types of index funds, but we’re fond of the exchange-traded fund (ETF). Different types of ETFs track different indexes, or portion of the market.
For instance, the ETF Vanguard Total Stock Market Index (VTI) is designed to emulate the U.S. stock market by holding a mix of U.S. stocks. On the other hand, Vanguard Intermediate-Term Government Bond ETF (VGIT) holds mostly government bonds. One ETF is tracking the U.S. stock market while the other is tracking the government bond markets.
Because one ETF can hold hundreds of different securities, having only a few ETFs in your financial portfolio can add instant portfolio diversification and costs far less than buying each individual security.
It’s important to note that there is no such thing as “no risk investments.” While a diversified portfolio of broad-based ETFs can be considered an investment option designed to minimize risk, stock market volatility (and market risk in general) can never be eliminated with any investment.
Okay, so now you know the steps behind the best investment strategy:
- Buy ETFS
What’s missing in this equation? You! Although passive investing is the vehicle to help you achieve your financial goals, you have to decide what those financial goals are. By determining these financial goals, you can shape the specifics of your financial portfolio, like:
which ETFs you’ll need
how much money you need to contribute to your portfolio
Chapter Three: Your Financial Goals
If you tell the internet you want to start investing, chances are you’ll get this piece of information: get an IRA and max it out.
That’s great, and we agree. You want to deliver the max contribution to your IRA in order to maximize the tax advantage of an IRA. But an IRA isn’t one-size fits all deal. That’s because everyone’s financial goals and preferences are different. Here’s where we get into things like risk tolerance and time horizon.
What is risk tolerance?
Risk tolerance is how much risk you’re willing to endure in order to get a bigger payout. Now, that doesn’t always mean that all risky investments have the potential for high rewards. Some risky investments are just stupid investments. For instance, investing all of your money in a Craigslist stranger’s elephant-breeding farm would be a risky investment that would probably also be a stupid investment.
However, when we talk about risk tolerance with ETFs and passive investing, we’re ideally talking about trying to achieve a reasonable balance between risk and reward.
This isn’t a hard and fast rule, but in general, stock ETFs tend to be riskier than bond ETFs, but also have potential for higher returns. There’s an antiquated “rule” that when creating a financial portfolio, your stock/bond allocation should be according to your age. So, if you’re 20, your portfolio should be 20% bonds, 80% stocks. The idea here is that as you get older, your risk tolerance lowers because you’ll need access to that money sooner.
So, what factors into your risk tolerance?
Time Horizon – This is how long you plan to stay invested. Generally, the longer a particular investing goal, the riskier you can get since you’ll have more time to recover from market fluctuations.
If you’re 25 and plan on retiring when you’re 50, your investing time horizon is longer than someone who begins investing at 40 and wants to retire at 50.
So, longer time horizon = riskier
Shorter time horizon = more risk averse
Personal preferences –
This is simply how comfortable you are with market fluctuation. For instance, one of the questions WiseBanyan asks to assess risk tolerance is:
If your investment lost money, would you sell some of the investment, sell all of the investment, do nothing, or buy more?
Lots of financial advisors ask their clients these kind of get-to-know-you questions in order to get an idea of their risk tolerance.
By examining your gut feeling toward risk along with your time horizon, you can better determine your risk tolerance. Understanding your risk tolerance helps you figure out what your asset allocation should be. If your risk tolerance is higher, your portfolio should be more heavily weighted in equity (stock) ETFs. If your risk tolerance is lower, you might want to consider a more bond ETF heavy portfolio.
Selecting Your ETFs
Okay, so let’s say you have this much down:
You’re 25 and have a nice, healthy appetite for risk. You know you want a more stock-heavy portfolio. Now what?
There are a gazillion ETFs out there, and plenty of brokerage firms to purchase them through. In our portfolios, we keep a mix of Vanguard, iShares, and Schwab ETFs, and we’re not alone. These ETFs are popular for their high diversity and low expense ratios.
Here are the ETFs we use:
You can create your own portfolio or get the help of a financial manager/advisor, which we’ll talk more about in Chapter Four.
So, remember in Chapter Two we spoke about the concept of rebalancing? Here we’re going to explain what that means.
Rebalancing Your Financial Portfolio
You’ve determined your risk tolerance, set up a portfolio, and have a passive investing strategy. You should be good to go, right?
Almost. Two things might happen along your investment journey:
One: Your portfolio may stray from its intended allocation.
Two: You may want to change your asset allocation
Let’s talk about each situation.
When Your Portfolio Strays From Its Initial Allocation
What do we mean when we say your portfolio is straying from its initial allocation? Let’s say your original portfolio is 40% stocks, 60% bonds. However, there’s a swing in the marketplace. While you still hold the same number of stock ETF shares and the same number of bond ETF shares, the value of your stock ETF shares has gone up. Now, your portfolio is closer to being comprised of 45% stocks, 55% bonds.
Sounds great, right? However, remember that you set up that original allocation for a reason. In this case, you wanted to be more heavily weighted toward bonds. So, what do you do in this kind of situation?
You rebalance your portfolio to match its original allocation. You’d sell off the over-allocated assets (in this case, the stock ETF shares) and buy more of the under-allocated assets (the bond ETF shares).
Deposits and withdrawals can also cause your portfolio to stray from its original allocation. We rebalance our clients’ portfolios any time they make a deposit, withdrawal, or there’s a price change in the ETF shares of more than 5%.
Now, let’s talk about option two – wanting to change your asset allocation.
Wanting To Change Your Asset Allocation
Let’s say you begin investing when you’re 20. Since you have a long time horizon and plenty of time to stick it out through market volatility, you have a portfolio that’s comprised of 90% stocks, 10% bonds. This is fine while you’re twenty, but as you move closer and closer to retirement, you’re going to want to rebalance your portfolio to be progressively more conservative. Why? Because when you’re closer to 65, you’re likely going to want a portfolio that relies more on the fixed income of bonds.
In this case, you’ll rebalance your portfolio to be more conservative moving forward.
Whew! You’ve come a long way. At this point, you have quite a bit of knowledge under your belt. You know:
- What a sound investment strategy is: The best investment strategy doesn’t offer unrealistic expectations such as how to double your money fast. Instead, it’s reliable, realistic, and attainable. In this case, we’re looking at passive investing.
- What passive investing is: Passive investing, or buy-and-hold strategy, involves creating a portfolio of index funds such as ETFs.
- How you should invest: Your financial portfolio is dependent on your time horizon and your risk tolerance. You might need to periodically rebalance your portfolio if it strays from your initial allocation. Additionally, you might change your asset allocation as your risk tolerance changes.
Remember earlier in this chapter, we mentioned you can create your own portfolio or you can hire someone else to do it for you? That’s what we’re going to get into next.
Chapter Four: Creating A Financial Portfolio – DIY Or Hire Someone?
Look, WiseBanyan is a (free) financial advisor, so we’re obviously going to want you to come to us, come to us! That being said, if we were talking to you buddy-to-buddy, whether or not you choose to DIY your portfolio completely depends on your individual situation.
Do I feel comfortable researching and sorting through ETFs to create my own portfolio?
Will I be comfortable periodically rebalancing, looking for tax opportunities, and so on?
Do I want to spend time calculating my goals, and strategizing about how to achieve them?
These are not trick questions. Yes, as a financial advisor we help you do these things, but you can do them yourself. The question is do you want to, and will you be able to consistently? Moreover, when stock market volatility comes a’knocking, will you be able to stick to your best investment strategy?
If you feel confident that you can handle your own investments, by all means – go for it. If possible, treat yourself like you would a client, maintaining a cool and collected perspective.
However, if you’re hesitant about building your own portfolio, rebalancing, or creating exacting calculations of your goals, consider opting for a financial advisor. Yes, back in the day these were prohibitively expensive and only made sense if you were rich, but things have changed. There are financial advisor no longer means a stuffy suit charging ridiculous fees for inefficient, expensive, and commission-based investments.
Instead, you can opt for an online financial advisor that helps you set and create goals and get there through well-tailored passively invested financial portfolios. A lot of these online financial advisors (including yours truly) have ditched their brick and mortar locations and use technology to operate more efficiently. Since they operate in a lean fashion, they can help you achieve financial success without costing you too much.
Remember: not all financial advisors are created equal. Therefore, we recommend you take a cue from our friend Billy Eichner and look for these key traits:
- Your financial advisor is a fiduciary (aka legally required to act in your best interest)
- Your financial advisor charges low (or no) fees
- Your financial advisor is not commissioned based (aka they do not profit from selling you certain securities)
- Your financial advisor is SEC-registered (aka legit)
- Your financial advisor is not a friend or family member
Number five isn’t a requirement, but it is recommended. It’s best not to mix investing with personal relationships.
Whew! You’ve made it far down this guide – congratulations!
Let’s recap what you know at this point…
- What it means to be a good investment
- The best investment strategy (woohoo passive investing and modern portfolio theory!)
- The importance of creating financial goals when investing
- Whether you should manage your own investments or hire someone
That is a LOT to talk in. If you’re feeling shaky about any of the info we just dropped on you, if any of this was confusing, feel free to reach out to use directly: firstname.lastname@example.org. We’re happy to answer your questions!
If you’re still thirsty for more, check out these resources:
If you’ve read this whole guide, we’re pretty confident in saying you got this – or at least you’re going to. Most of the battle with investing is educating yourself. If you start your investment journey armed with knowledge and a sense of zen, you’re on your way to a win.