Chapter 8 - Investing

How to Invest Money

The Capitalist economic system is alive and well and is global. You are part of it and you need to know what it means to your household finances. In capitalism the machines of production of goods and services in economies is separate from those who work the machines. The people who own the machines share the returns of production with the workers. The emotional and mental challenge for most folks is that in one way or another they are engaged on both sides.

The regular Joe or Jane works for hourly wages or a monthly salary. In most cases they save up money to invest on their own or they will save in some sort of retirement pension plan and that money is invested to buy bonds or shares in companies that regular Joes and Janes work in. Since the economic crisis in 2008, I think everyone is aware that they are exposed to this reality and that what happens at the Towering Heights of the economy affects personal finances.

In the environment of investments you work all day and then have a little time to work on your family finances and even less to devote to managing your investments. Meanwhile there are giant institutions that employ fulltime workers to manage or steal your nestegg. The giant institutions will always pay themselves first and they will always get paid whether your investments with them gain or lose. How does the regular family protect their savings and investments? Who and what do your protect your self from and how do you protect your investments in this environment?

The first rule of business is the KISS rule…Keep it Simple Stupid. If some investment scheme is too good to be true it most likely is. If decision making is so complicated in a fund that you just have to trust the manager of that fund, you should see a big red light for you to invest. You have to be able to see how your investment works with someone’s skills and talents to add value to a product. At some point when you loan someone your hard earned saving you know there is a risk of it being lost. If it is low risk, the rate of return is low. For guaranteed investments where the safety of your principal and the interest are guaranteed through banks and insurance companies, the safety is high but the return is almost 0. If you want to make higher returns you have to take risks. Takings risks is a skill and you need to prepare yourself. You learn how to do due diligence. Due diligence is asking the right questions to find out if the company that you are investing in has a viable plan, is honest and can actually execute their plan. To ask the right questions you need training and field experience. You need to develop your rational skills and your intuitive skills. You need to read and take courses. With practice you learn how to read situations and people. You develop an intuition which will give you a “gut feeling” to go with your analytical conclusions. You will make mistakes so you do not put all of your eggs in one basket…you do not invest everything in one opportunity. For many of the folks who lost their savings in the 2008 fallout, many made this huge error. They invested all of their money in some Ponzi scheme or fraudulent investment house that went bankrupt. If do your due diligence is the second rule of investing, the third, fourth and fifth rule are DIVERSIFY, DIVERSIFY and DIVERSIFY. Invest in different things. Have your money accounts in different banks. If one fails you still have 80% to 90% of your money left. You should never set yourself up to the risk that you will lose everything that you have invested. The other facet of diversification is that you diversify your risk. You have worked hard to save your investment capital so you need to respect your efforts enough that you will protect most of it in low to medium risk investment tools. If you crave higher risk do so with a small percentage of your investment portfolio. Age has a lot to do with risk tolerance. If you are young you can take some chances. You have more time to recover from mistakes plus that is how you learn that you need to do more due diligence and you develop investor intuition. Older investors need to protect their nestegg but they need income from it. They are less tolerant of risk but should be more skilled at managing the risk. Investing is never easy.

The process of learning investments follows developmental steps that are paralleled by aging. You go through developmental stages in all of the facets of your life and your investments evolve as you do.

Starting out

You are in your late teens and into your twenties. For the author that was a time when I was young and stupid. It is the best time to be young and stupid especially about your money. You have lots of time to recover and you find out the dangers of high risk behaviour. While you are engaged in this behaviour, there are some things that you can invest in. The first is an education. My Pappy used to say, “They can never take it away from you”. I never knew what he meant by that for decades. Later I figured out that he meant no matter how hard you try, you cannot unlearn the life skills you develop while getting an education. If you are able to use your education to get a better job, that is a bonus. The real bonus is that you learn how to read and express yourself. You develop analytical skills that you can apply to any facet of your life.

You learn how to live on a bare bones budget. When you get out of school you start investing in the tools you need to make a living and the tools you need to function in society. For most kids, the first big investment is a vehicle. You are young and unattached so you will be offered jobs that require travel. You will need reliable transportation. If you are one of the sharper tools in the shed, you will start saving some money in the simplest of savings instruments. The earlier you start savings accounts the better. If you get compound interest working for you earlier you expand your investment options as you evolve. You can move into what are called Certificates of Deposit or Guaranteed Investment Certificates which offer improved interest rates and the same amount of safety for your new nestegg. Savings is challenging to accomplish when you are young and busy. You are just starting into the working world and pay rates are low for most youngsters. Then there is so much to spend money on. The challenge is to be patient and let your youth work for you.

Intermediate

When you get established in the workplace and in family life, you develop the awareness and desire to take on more demanding investments. If you were smart enough to establish some savings, leave them alone and keep saving. This can always be the safe part of your portfolio. Your core retirement savings should be a separate and constant part of both your budget and your balance sheet. It is the foundation of your portfolio and should be conservatively invested. You can weather the ups and downs of your other investments but to lose your retirement savings is devastating on your psyche.

The biggest investment for most folks is a house…a family home. It is a good investment in so many ways. First it almost always will increase in value over time. You should buy your home with the expectation that you will spend most of your adult life in this home. Moving requires spending 10% of the value of the house on agent cost, transfer costs, and moving costs. Note that the move is paid for out of your equity money. To move when you have less than 50% equity in a house you will spend twice that percentage of your equity or more. When you stay in a house long enough to pay off the mortgage, you reap a multitude of benefits. Your banker will always call you sir and you will get the best rates and service that they can offer. This is because you not only have an asset that you can sell; you have shown the financial skill to accumulate a large asset over time. It is because you have freed up the 30% of your income that is allocated to paying for accommodation. That is a lot of cash flow that you can spend or invest. And that should be for the rest of your life.

Through the middle years of home ownership, you can manage your cash flow to either pay off your mortgage sooner than the amortization period. You can enjoy that your income will increase over the years and that your mortgage payment should be going down as a percentage of your income. This allows you to invest money in your kids’ physical, mental and emotional development because you will have the cash flow to pay for activities and sports. You will have money to put away in their educational funds.

You will also have money to invest. You may want to start your own business or you may wish to invest in other peoples’ businesses. You can try out different investment vehicles and learn the skills necessary to become a “Sophisticated Investor”.

Sophisticated

One definition of a sophisticated investor is “a person who has a lot of money”. In 2009 the media has been full of stories of such investors who have lost a lot of money. So if you want to keep your money you obviously you need a more complete definition of sophisticated investor to set as your standard. The first requisite is that you need to live by the 5 laws of investing outlined in the introduction to this chapter. You need to develop a strategy that works for you. There are a lot of investment choices and you cannot do it all. So keep your choices simple and invest in things that you know. When you do invest do your “Due Diligence”. Know what you are getting into and what the risks are. Know the people you are investing in and know the product. I know of a lot of people who have money invested that do not do this and are fortunate that they do not invest in the wrong people. It is not because they did their homework. Try to leave chance out of it and make sure that you do yours.

The next 3 laws are “diversify”. Not only diversify your holding but your risk levels. Know what is out there and what the risk is for each kind of investment. Here is an outline of what you will see offered to you as investments.

  • Bonds…There area all kinds of bonds. There are government bonds and corporate bonds. There are short term bonds and long term bonds. Some have simple interest and some have compound interest. For some the redemption value floats and for others it is pegged. You need some training to be involved in serious trading of such securities.
  • Stocks…The original concept of share offerings was that you bought a “share” of the company and would get a proportional share of the increase in value of the company. In some cases companies declare dividends to share the quarterly profits that the company generates. In present offerings the concept is there but few stick to the original simple concepts. You need some training to be involved in serious trading of such securities. Check Stock Prices
  • Mutual Funds…You can buy shares in Mutual funds. The managers of the fund will do your due diligence for you and the goal is to invest for mutual gain. Some are managed better than others. So you need to do due diligence to sort out who is best to manage your money. In your due diligence you will come to understand that there are fees and costs charged by the managers of the funds to the shareholders. Whether the fund performs well or poorly these fees are taken. Also some funds charge more and/or more often than others.
  • Real Estate…You can buy properties and rent them out. You can buy properties and wait for them to appreciate in value. You can develop properties or buy into companies that develop properties. Some work out and some don’t. Do your due diligence before risking your money.
  • Private Companies…This is where most companies start. You do not just come up with a product and an idea and then sell stocks and bonds to raise capital. It is raised by canvassing potential investors for money to start up the business. As the company grows it may still need capital infusions to continue growing until it is has established itself enough to pursue financing by listing stocks or bonds on an exchange. This is a more common way for companies to finance themselves in Europe than in America. It is a good way to make higher returns on investment. Do your due diligence before risking your money.
  • Start ups…These are the most junior of Private companies and you need to be wary of the potential of a start up. Know that only 1 or 100 start ups will become a viable business and only 1 of a 1000 makes the amount of money to reward your risk. At the very least you will wait a long time for your return. At the very worst the venture fails. You may pursue the return of your investment through litigation and see only pennies on the dollar after a long legal process.
  • Hedge funds…It is like a mutual fund with a very gifted manager who has a reputation for very high returns. He shares his skill with you for a very high percentage of the gain. Fees are also high and taken whether the fund has success or loses money. In the event that the fund is managed to bankruptcy, the management of the fund is not liable and the investor is left with little or nothing.

This is not a comprehensive list. There are many versions of the listed instruments and there are other types of investment out on the markets. In all cases there are those who operate with integrity and there are those who are cheaters, schemers and scammers. They all walk the same and talk the same. The presentations are all so similar. They all dress the same and have the same haircuts. They all have the “integrity look”. But because they walk like a duck and talk like a duck does not mean they are a duck. This is where you really become a sophisticated investor. You develop the intuition about the guys who pretend to have integrity and then you know where to look to expose them when you do your due diligence. It usually comes out when you inspect their financials. There will be glaring inadequacies when you know what to look for. If you can read and understand the two books offered below, you can call yourself a sophisticated investor.