Before moving on to the next financial area, let’s finish off with three key investing concepts.
Bull & Bear Markets
We speak of a bull market when share prices go up over a period of time, leading to more market activity and people wanting to buy more, thereby driving up the prices further. The opposite of a bull market is a bear market, during which prices generally go down, with many investors often wanting to offload their shares to avoid any further losses. Continue reading “Day 24 / 31 Investing Concepts”→
Now that we have covered the basics of investing and the stock market, you might still be wondering whether investing is the right move for you. This challenge starts with looking at reasons to invest, followed by some reasons to hold off investing, after which you should be able to make a more informed decision.
Why should you invest?
Let’s start with some of the main reasons that makes investing worthwhile to many.
Investing is an alternative to saving: by setting money aside people hope to grow it and with time build up a nice small capital.
Over long periods of time, the stock market generally goes up. Even if there is the occasional crash when stock prices go down, if you have the time and the patience to sit it out and wait, the market will recover again.
On average the markets go up by somewhere between 7-10% yearly. That is more than most yearly inflation rates;
The market average is also normally higher than interest rates offered on saving accounts;
Another fun advantage of investing: many people like to track their shares and see how they are doing with their investments.
Oh go on, one more investment related step before we end the series on investing… Despite its very boring name, dollar cost averaging is a powerful investment strategy that actually makes market volatility work in your advantage.
This is achieved in two ways:
When the market is up you buy less shares, thereby avoiding investing a lot of money when shares are overpriced and when a crash might be just around the corner;
When the market is down, you benefit by buying more shares, thereby making the most of the shares being “on sale”.
Let’s look at how dollar cost averaging works.There are generally two ways to invest: investing a lump sum or investing a set monthly amount. As we know markets go up and downs all the time and although most markets go up over time, they still experience periods when prices drop.
Lump sum investing
Imagine you have a windfall of say $10,000 that you want to invest. If you invest it all in one go at a time when the market is climbing, this might be a very poor moment to invest this money. Wait a few months and the market might well experience a downturn:
Say the average price of shares at the moment is $100 then (costs excluding) you’d get 100 shares for your $10,000.
Imagine the prices drop to $80 on average in the next 6 months. If you had held off investing for 6 months, you would have been able to buy 125 shares, i.e. 25% more!
Now let’s say that another 6 months later the price of shares is back up to $100 a share again. If you entered the market today, you would have gained nor lost anything in a year’s time. Had you entered the market when shares were only $80 a piece, your portfolio would be worth $12,500 in a year’s time.
In the previous step we looked at how investing in Real Estate can be an interesting addition to your portfolio in order to spread your risk more and generate another new income field. In this step we will look at another way to diversify your investment portfolio which is through commodities and gold.
Investing in commodities
Commodities (or natural resources) are important for the stock market in two ways: firstly many companies rely on commodities. If you have any Coca Cola shares then of course sugar prices at some point affect Coca Cola profit and therefore share and dividend prices. For any shares you might have in big retail or fashion stores wool prices will affect these share prices at some point in the chain and many other companies might rely on such commodities as oil, copper, grains and aluminum.
Apart from their importance to the companies that trade on the market, commodities play another part on the market as they too can be invested in directly, just like shares and bonds!
There are generally two commodity classes:
Soft commodities – cocoa, wool, cotton, wheat, rice, coffee etc. These prices can fluctuate a lot, especially when a shortage exists (think about a bad harvest for grains, rice, potatoes or coffee for example and how this can drive up prices). Apart from the weather, also a growing population as well as people’s eating patterns effect these prices.
Metals – zinc, aluminum, copper. Prices are less volatile as their time takes much longer: a new mine takes much longer to open and operate. It’s easier to predict how prices are affected, also if new technologies such as microchips are developed that require more or different metals.
We’ve looked at investing in the stock market in detail and how stocks and bonds offer the opportunity to create and maintain wealth over time (but remember that investing in the market always has the risk of losing a lot of your money too…). In order to spread risk when investing in the market, creating a balanced portfolio is generally the recommended way to go, in which your money is divided over many different companies, industries and markets and investing opportunities.
Whereas many investors have big chunks of their money (if not all) invested in a mix of bonds and shares, there are also other investment options to consider in addition to stocks and bonds that offer an extra diversification to your portfolio. In this step we’ll discuss one common alternative or addition: real estate, whereas the next step looks at investing in gold (and precious metals) as well as commodities to complement investment portfolios.
Investing in Real Estate
We have of course already discussed the option of buying another property and renting it out to a tenant as a way to invest your money in order to generate an additional income stream as well as the possibility of a capital gain on the estate itself in the long-term. This is one way of investing in real estate, but there are other market options to invest in real estate, including:
REITs – Real Estate Investment Trusts – similar to a mutual fund, REITs trade on the market. A trust pools together investors’ money in order to purchase real estate and rent it out to generate income. The advantage of REITs is that they must pay out a big chuck of their profits as dividend in order to keep their status as a REIT, meaning that returns can be very interesting. You of course don’t own the property but own a part (like a share) in the trusts’ property portfolio. Like stocks and bonds you can sell your part to other investors and REITs go up and down in price similar to the rest of the market.
Real Estate Investment Group – This option is ideal if you want to actually own another property to rent out but don’t want to deal with the hassle that comes with it: finding tenants, collecting rent, dealing with maintenance issues etc. As an investor in a real estate investment group you buy one or more units or flats of a bigger apartment complex owned by an investing company. By buying a unit, you become part of the Real Estate Investment Group and become the owner of the flat, but the investing company will deal with all the day-to-day issues and operating of the units on a collective basis. They will take a part of the rent you generate so you still profit from renting out your property, but you have very little to do with the day-to-day operating.
Real estate trading – Also known as Flipping, this is a practice in which somebody buys a property, hold it for just a short amount of time, usually only a few months and then sell it again at a higher price. This is especially effective if one is able to buy a property in a hot spot or if one acquires a building that is highly undervalued and therefore a bargain to buy and then sell again. This is a different way of investing in real estate and contrary to capital gains over a long period of time, real estate trading is focused on capital gains made in just a few months. Bear in mind that taxes on short-term capital gains can be significantly higher though.
Investing in real estate can be housing, but can also include other types of real estate such as commercial property (think about offices and factories) as well as old age pensioner’s homes for which demands are increasing all the time due to aging populations.
Let’s look at one more pension option before we round off the pension series: Annuities. Sounds like something complex (and they certainly can be when they want to be!) but this step will break down their characteristics and benefits, as well as some of their disadvantages.
What are annuities?
Annuities are a financial product somewhere between an insurance and an investment option. Like any insurance, you buy annuities – in this case it insures you against living too long. Yes, you read that right. Whereas a life insurance insures against dying too early, an annuity insures you against living too long. An annuity provides a set monthly income that you get for the rest of your life after a certain age. If you are fearful that you might outlive your pension, i.e. that you might withdraw too much from your investment and / or pension fund and end up without any money at some point in your retirement, an annuity is a good solution as it gives you a guaranteed monthly income.
How do annuities work?
There are many different types of annuities with many different characteristics. First of you normally buy an annuity from an insurance company, pension provider or broker who then reinvests your money. It very much works like a mutual fund and the company you buy the annuity from will add in a profit margin of course so your money won’t grow very much over time due to the fees you pay. You can buy an annuity with all of your pension savings just before you retire or you can buy several smaller annuities over time. Annuities differ in the way that they are set up and some of the key variables include: Continue reading “Step 88: Annuities”→
A difficult question that many people on their mission to financial independence quickly encounter is “where they should get their money to work for them”: You’ve managed to cut down a little on your expenses, or to up your income or earnings from a side hustle. But the question as to what to do with the extra money you now have remains. Let’s review some of the avenues on how to “make money with your money” that we have looked at on this mission:
Paying off debt – saves you money on interest and compounded interested paid over the years.
Saving – generates money due to interest received and the power of compounding interest over the years.
Investing – generates money due to capital gains, interest received or dividends.
Pensions – builds up the income you’ll receive after your retirement age
Personal capital – increases your earning potential as a professional or entrepreneur.
These are the most common strategies to pursue in order to leverage what your money can do for you.
But where to start? Say you saved $100 this month and that you are happy to invest this money into your future and future earnings, where do you actually put this money? Which of the above options do you choose? And how do you mix these strategies?
If you haven’t yet fully read the previous steps on the above mentioned strategies, I invite you to read those first before continuing reading this step, to better understand all the pros and cons of each strategy. Just come back once you’re done!
The question of where to allocate your money doesn’t have to imply an “either …or…” situation. You can start investing whilst still having a mortgage. You’ll want to save an emergency fund together whilst still paying off credit card debt. And once you start investing in your personal capital, you’ll likely want to keep that up on a fairly regular basis and the fact that you are investing in the market doesn’t rule out this option. Continue reading “Step 85: Plan your Money Allocation Strategy”→
After all these steps on cutting expenses, building up savings and investing to build a pension, it can become easy to dismiss any investing in yourself at all, especially in your intellectual abilities as a professional.
You might have got to a point where you’ve got all your daily costs taken care of: you’ve got a good, solid budget that you are happy with and able to stick to, you have short-term savings goals set up that you contribute to monthly such as a holiday or a new laptop and you even have your long-term savings on track in the form of pensions, paying off your mortgage and / or investing in the stock market.
When you get to this point it becomes easy to get completely taken up by this popular personal finance motto:
Earn more, reduce your spending, invest the difference.
And whilst there is nothing wrong on paper with the above guideline, it is easy to get a little too distracted by this, to become too frugal and forget what else is important in life. In step 75 we looked at how spending a little on yourself every now and again is important to not forget the importance of “YOU” and to make space in your budget to reward or treat yourself.
But what about your intellectual or professional development? When you get too sucked up by financial independence, be careful not to overlook the importance of individual capital and the need to invest in this aspect of yourself, over putting the money into more investing or savings. Continue reading “Step 83: Invest in your Individual Capital”→