Whether you’re just starting life on your own or in the middle of your career, investing means that you’ve begun to think about your financial future, and how you might manage your capital.
Nobody starts out an expert (not even Ramit). Even the best investors once sat where you are- asking themselves two fundamental questions;
- Where should I begin?
- How do I begin?
If you’ve come across a bunch of intimidating investing terms before, these questions might seem daunting.
At its core, investing is about putting down money today with the expectation of getting more money back in the future. That’s it.
Most of the time, the best way of doing this is by acquiring productive assets. Which are investments that internally throw off surplus money from an activity? For example, if you buy a painting, in one hundred years, you’ll still only own the painting, which may increase or decrease in value. But, if you buy an apartment building, you’ll have the structure, but you’ll also have the cash from rent and service income.
Productive assets can be divided into a few major categories. The three most common kinds of investments are stocks, bonds, and real estate.
Investing in stocks usually means investing in common stock, which is another way to describe business ownership or business equity. When you own stake in a business, you are entitled to a share of the profit or losses generated by that company. Equities have historically been the most rewarding asset class for investors looking to build wealth over time without needing to use large amounts of leverage.
Investing in privately held businesses
Businesses that are privately owned have no public market for their shares. They can be a high-risk, high reward proposition.
You come up with an idea, establish a business, run the business so that you have more money coming in than going out, and grow it over time.
You might start a partnership with somebody, where you each put up a certain amount of capital and divide the profits accordingly, or you might lend someone the money for their business, and receive a certain amount of profits, for a certain amount of time.
Investing in publicly traded businesses
Private companies sometimes sell part of the company to outside investors. This means that anyone can buy shares and become an investor.
The types of publicly traded stocks you own might change depending on several factors depending on whether you prefer your companies stable and profitable, or whether you prefer to take significant risks and invest in bad companies because a small increase in profitability could lead to a substantial jump in the market price.
Investing in Fixed-Income securities
When you buy fixed income security, you are lending money to the bond issuer in exchange for interest. There are a few different ways to buy, from certificates of deposit and money markets to corporate bonds, municipal bonds, and savings bonds.
Similarly, with stocks, many fixed income securities are purchased through a broker. When you open a new brokerage account, the minimum investment can vary, usually ranging from $500 to $1000.
There are several ways to make money in real estate, but it comes down to either developing something and selling for a profit or owning something and letting others use it in exchange for rent or lease.
Real estate has been a path to wealth for a lot of investors because it easily lends itself to using leverage. Applied to the right investment, leverage can allow someone without a lot of net worth to rapidly accumulate resources, which means they have a far larger asset base than they would have otherwise.
How do you want to own those assets?
Once you’ve decided which asset class you want, your next step is deciding how you’re going to own it. For example, let’s look at business equity. If you want a stake in a publicly traded business, do you want those shares outright, or through a pooled structure?
If you opt for outright ownership, you’re going to be buying shares of individual companies directly. This requires a very high level of knowledge.
When you invest in stocks, you need to think of them in the same way you would privately held businesses. This means you need to focus on the price you are paying relative to risk-adjusted cash flows that the asset is generating. Learn how to calculate enterprise value, calculate gross profit and operating profit, and compare them to other businesses in the same industry. You’ll need to read the income statement and balance sheet.
When you invest in stocks through a pooled mechanism, such as a mutual fund or exchange-traded fund, you mix your money with other people and buy ownership in several companies through a shared structure or entity.
Pooled mechanisms can take many forms. Some investors invest in hedge funds but most opt for exchange-traded funds and index funds, that means they can buy diversified portfolios at much cheaper rates than they could have afforded otherwise. The downside to a pooled mechanism is a near total loss of control, you’re just along for the ride, leaving all decisions to a small group of people with the power to change your allocation.
How to start investing
If you aren’t self-employed, your best course of action is going to be signing up for an employer-sponsored retirement plan as soon as you can. I’m not going to go into much detail about them, because I know they vary a lot country by country, and I’m self-employed.
If you are self-employed, you will want to consider a term deposit or even a regular savings account, if you don’t have a lot of capital.
Even $10 a week into a long-term savings account can make a huge difference throughout twenty or thirty years.
If you are looking to plan for the future, no matter how distant, your first port of call needs to be your HR department or the bank. Not the broker.