Wow, who knew that just any regular Joe could themselves become a Computer Person by simply learning some basics about how a computer works and what it can be used for?! Amazing! Similarly, any average person can actually become an expert investor, leagues above their peers, by simply understanding and following a very simple approach.
In my first post, I talked how how money can be used as a tool to give you freedom rather than just a medium to collect junk and how being financially independent gives you tremendous freedom to pursue your interests in life. In order to reach financial independence in a reasonable time frame1Reasonable = 15 years or less for anyone and be able to survive for infinity years without running out of money after doing so, we need to work for ourselves (i.e. have a job that makes us money) AND make our money work for us, rather than just bury it under a tree. The way we do this is by investing, or what I like to call playing Offense.
There are many avenues available for playing Offense, and some are certainly better than others. To decide which is/are best, I’m going to define two criteria that we want out of an investment avenue:
- Performance: We want to invest our money somewhere that will give us a reasonable, if not spectacular, return on our investment.
- Convenience: If money is a tool that can give us freedom, then our investments shouldn’t require a lot of time, energy, or maintenance since we’re all busy people that have better things to do with our time than waste it all managing our investments.
With those things in mind, let’s consider some of our options:
- Interest-based investments: These are things like savings accounts, high yield checking accounts, or Certificates of Deposit. Essentially, you let a bank hold your money with or without some restrictions imposed on your access to it in exchange for some interest. In general, and especially at this current time, these lack in performance. You’re never going to get rich off of a 1% interest savings account that doesn’t even keep up with inflation. So, excluding a primary checking account in which you receive your paycheck and from which you might pay some bills, we’re going to forget about this category for a while.
- Debt-based investments: These include corporate bonds, government bonds, or even peer-to-peer lending. Debt-based investing will give you better performance than the first category, but we can still do much better. However, what debt-based investments lack in performance they partially make up for in reduced volatility2We’ll define volatility as the fluctuations in the value of your investments over time, and talk more about volatility in future blog posts.. They can also be a pretty convenient investment. So, let’s pocket the idea of debt-based investing for now as something that isn’t the best performer but could be useful in specific situations.
- Real Estate: This includes investing in property, whether that’s a house, apartments that you rent out, or even funds like Real Estate Investment Trusts (REITs) that will take your money, invest it in property, and pay out the profits to you. Real estate actually does quite well in the performance department, but also has several downsides that prevent it from being the obvious choice. The first of these is a general lack of convenience. You and I are busy people. Heck, we barely have time to read and write blog posts in the midst of our busy schedule. So we have to ask ourselves: Do I really have time to buy and sell properties? Or manage tenants? Or fix broken pipes? We could go the easy way and invest in REITs, but unless that money is in a special account3We’ll talk about what that means soon!, it will be taxed as we make it, decreasing it’s performance. Real estate can also be quite volatile and it can also be difficult to diversify your investments (how many properties can you afford to buy right now???). So, while I wouldn’t call myself a Real Estate Hater, I don’t think it’s the best choice for most, if not almost all, people.
- The Stock Market: Investing in stocks means becoming a partial owner of a business or businesses. To do this, you buy shares of the company. The more shares you buy, the more of that company you own. For example, if company Dirty X has 200 shares outstanding, and you buy two shares from somebody else who is selling two shares, you now own 1% of Dirty X. Congratulations, you’re a Dirty business owner! As a partial owner of a company, when the company profits, you profit. Profits can be paid out to you in the form of dividends, or can be reinvested in the company in order to accelerate the growth of the company so that it is even more profitable in the future. So, how does the stock market do in terms of performance and convenience? For the past 140+ years, the average annualized return of the stock market is 7%, AFTER accounting for inflation (so the actual returns are significantly higher). Seven percent. What does that mean? Consider a $1,000 per month investment, every month for 30 years. Over that time frame, you’ll have put in $360,000. But at an annualized return of 7%, you’ll end up with nearly 1.2 MILLION DOLLARS! Woah! Who knew you could become a millionaire just by saving $1000 a month?? Ok, so performance is up to par. Convenience? Well, if you do this right, investing in the stock market will be very convenient indeed. Save some money, buy some stock, and then forget about it until you’re ready to retire. Of course, if you’re spending hours a day day-trading, then the convenience factor goes out the window. And, as we’ll soon find out, so does performance…