In the previous step we’ve looked at asset allocation and using the yearly rebalancing technique to keep the right balance between your various assets in your portfolio, even if some of your assets grew more than others, thereby taking up a bigger percentage of your portfolio. In step 73 we’ll look at how rebalancing your portfolio can also help to readjust your portfolio when you get closer to your goals. In the examples below I mainly use retirement as a goal, but it can of course be other goals too that you might have in mind for your investments, such as a college fund for a (grand)child, a down-payment for a house etc.
Let’s assume that you have a 70/30 shares / bonds allocation to start off with in your portfolio and that the main goal for that portfolio is to use it as (an addition to) your pension provision. With time when you start nearing retirement, you might become a little nervous about the possible volatility of this portfolio however. What happens if there is a sudden crash in the market and you lose a big chunk of the money in your portfolio right before or after you were planning to retire? It means you suddenly wouldn’t have the same amount of money available that you maybe planned to have, which would probably compromise some of your pension plans. Of course when you’re 30 or 40, having a portfolio with a bigger risk factor doesn’t matter as much as your portfolio still has time to recover after a possible crash before your retire. But when you’re close to retirement age, you don’t have the same luxury of time and you probably don’t want that same volatility anymore as when you were younger. Continue reading “Step 73: Lifestyle Investing Option”→
This and the next step look at managing your assets in your portfolio on a long-term basis to ensure they remain aligned with your goals. With time some assets might grow faster than others, goals might change or you might want to change the risk level of your portfolio the closer you get to your goals. In all cases this can be dealt with by rebalancing your portfolio and re-allocation your assets. Similar to the investing principle of “buy when everybody else is selling”, which we discussed in step 54, the rebalancing of your portfolio is another investing concept which is easy to understand and execute logically, but can be difficult to implement psychologically.
The yearly rebalancing of your portfolio ensures that if one area of your portfolio does really well in one particular year, you don’t deviate too much from the original asset allocation that you had in mind for your portfolio. If one assets grows much more than another, it might make your portfolio too volatile or too safe for your goals and risk tolerance.
Let’s look at an example and assume that you want a 70% shares and 30% bonds allocation in your portfolio. You put in $10.000 and the moment you enter the market both bonds and shares happen to be $100 per unit. Ignoring costs for the sake of this example, that means you’d have $7.000 in shares and $3.000 in bonds. A year later the shares have far outperformed the bonds, and even though both have gone up in prices, your bonds are now worth $3150 (a 5% increase), whereas your shares are now worth $8050 (an increase of 15%). The stocks and bonds allocation is now no longer 70/30 but 72/28. Not a huge difference you might think but if the shares keep outperforming bonds by that much for a few years, you might end up with an 80/20 portfolio in just a few years. Continue reading “Step 72: Rebalance your Portfolio”→
Once you’ve got a taste for investing, you’ll likely want to investigate other options that allow you to invest some money, either to diversify your portfolio, support a small start-up, increase returns or simply for fun to see what happens.
A hugely popular new way of investing (or indeed raising money if you are on the other side of it) is crowdfunding. Crowdfunding is a way for companies, entrepreneurs and start-ups to get together a sum of money to set up a business, launch a new product or expand and open a new project or department.
Types of crowdfunding
There are different types of crowdfunding:
In P2P (peer-to-peer) lending, capital is raised by getting many different loans of small amounts together. Instead of getting one loan of $30.000 from the bank, entrepreneur(s) might get as many as 200 different people lending them amounts between $50 and $1000 for example. Like with a bank loan, the entrepreneurs are then paying the loans back over time with interest to their investors.
Pre-sales in which people can pre-order even before a product has been produced. Those initial investors will get a first release or even a small present several times a year (for example a new exclusive wine or another small new release).
Selling shares and having people invest in your company in return for a small ownership in your company.
In the previous step we looked at the advantages and challenges of choosing the shares and bonds to invest in yourself. In this new step we look at an alternative which is designed to help you if you don’t want to choose your own investments, but rather rely on the opinion and experience of somebody else: Investing through collective or mutual funds.
As we’ll see, this type of investing has its own major positives and drawbacks so let’s get started with the details.
Mutual funds – an overview
In the case of collective or mutual funds, the money of small investors in pooled together in order to raise the total amount available to invest. A fund manager is appointed to manage these funds and he or she decides which shares and bonds to add to the portfolio, trying to make as much money as possible. This often means they buy and sell continuously, following the market, aiming to buy shares at a low price, sell them at a high price and rush selling if they see a fall in the market coming, to avoid their clients losing a lot of money. Sounds like a good tactic? On paper yes, but in reality there are two main problems with this type of investing. Continue reading “Step 51: Investing through Mutual Funds”→
Now that we’ve discussed the what of investing (stocks and bonds and what the differences between the two are), it is now time to learn more about the how of investing and in particular how one can enter the stock market and start investing. Hopefully by now you’ve at least become slightly curious about how this investing really works, whether or not you feel like this will be your thing to do.
Generally speaking there are three different ways you can invest in a stock market:
Handpicking shares (and bonds) of individual companies
Getting a collection of shares and bonds through collective or mutual funds
Passive investing through Index tracking or Exchange Traded Fund
We’ll look at each option in turn to find out more about each way of investing in detail. In this step we’ll start by looking at handpicking shares of individual companies. Remember that these steps are only an introduction to the complexity of investing, so don’t just take my word for it, but read up if you’d like to find out more. There are many good books, articles and websites around that will explain this all in greater detail.
Stock markets have a vast selection of stocks and bonds that can be invested in and before deciding what to invest in, understanding the main differences between stocks and bonds well is absolutely key if you consider getting in the stock market. Investors can decide whether they want to invest in just shares, just bonds or whether to create their own mix of stocks and bonds. With time, many furthermore decide to slowly reallocate their investments, so even if you start with a certain percentage shares and bonds, this needn’t stay as such for the rest of your investment life.
Here we’ll look at the main differences between shares and bonds from an investor’s point of view and how they both offer different advantages and disadvantages.
Share prices vary more day-to-day but also over long periods of time: their value can increase or decrease fast.
Bonds are generally more price solid and fluctuate less over time and at a much slower pace than shares.
Here starts a new part of our 100 steps to financial independence, with this being the first step in a mini-series on investing.
If you are serious about money, it is worth understanding more about the stock market and at least get a basic idea of what it is and how it works, before you decide for yourself whether investing will be something you would like to start doing. Investing is often a long-term decision and depending on the risks you are willing to take, you might or might not feel that investing is the right thing to do for you.
Let’s start with one of the key components of the stock market: shares (also known as stocks) and find out what they are, why they exist and how they make or lose us money.
Time to look at our 5th possible income stream, which is dividend income. This type of income is based on company profits paid out to the shareholders of that company. Before you dismiss this type of income as not your thing, read on and then jump to the investing steps later on, as you’ll find that investing can be more or less risky, depending on the risk that you feel you can deal with and you can start with very little money, yet over the years build up a considerable portfolio.