This blog will address some introductory points of investing and offer some thoughts on how to be intentional with your investments. Much of this comes from a blend of learning the hard way, years of reading, and formal education. These are points that work for me, and I hope they will serve you well on your journey as well.
This post is the next installment of the “Getting Started” Series. As always, continue to cultivate and apply Mêtis in your Money Matters. Congratulations on all the hard work you have invested! Take a moment, and look at the progress you have made! At this point you should have a solid Budget, an Emergency Fund established, a Life Insurance policy in place, and Retirement accounts firing away in support of your personal finances. Remember to take time to celebrate the wins!
BE INTENTIONAL WITH THE ADMINISTRATION OF YOUR INVESTMENTS
It is very important to take the time to manage the administration of your portfolio. For example, to the extent possible, understand what you are truly investing in at the onset of your transaction. For example, try to avoid any surprises when you need the money such as being unable to exit your position due to trading restrictions.
At the end of the day, make sure you have a handle on what you signed up for. This is true for investing on small and large-scale levels. As an example, you should have a plan for your 401(k), for your Roth IRA, and for your online brokerage, etc. It is important to be intentional with your investment administration on an individual level, and on a holistic portfolio approach.
Be Intentional with Fee Structures and Costs associated with Your Investments
Fees and Costs can make or break an investment selection. Be very careful. Before you transact on a particular investment, make sure you know what you are going to be charged. Make sure you know what you are going to be charged before you transact on a particular investment. One way to by reviewing a schedule of the fees. Various investments may have different names, but the information should be available. You can save time and money with a little effort up-front, prior to investing, by taking note of the fees.
Fees can come in all forms. One way to identify these is in the prospectus. Another way is to review the expense ratios. Generally speaking, lower is better. A flashy fund that has a higher historical return “on paper” may actually be underperforming when compared to a low-cost ETF. (Especially when you factor-in your fees and costs). Also, remember, past performance is no guarantee of the future. Make sure you account for the impact of the higher fee structure if you decide to buy a fund or investment that is relatively more expensive.
The other cost to think about is the opportunity cost. The choice to invest in one place is also the choice not to invest in other funds, thereby paying an opportunity cost to participate in those returns (and losses). Keep this in mind when weighing your options on an individual and portfolio level, and chose the option that best compliments your overall portfolio position.
Be Intentional with Liquidity and Access to your Investments
Be intentional with you investment selection by carefully considering liquidity and access to your funds after the trade has been executed. As we discussed previously, a flashy fund might also be thinly traded, and it may have all sorts of restrictions on withdrawals. Given those considerations, the fund might not be that attractive after all. Make sure you know what you’re signing up for!
A lot of information is available in a prospectus. For example, it should detail what holding period requirements there are in one form or another. As an example, a fund might stipulate that investments are required to be held for 90 days (as an example) or longer. In addition, there may also be an additional trading fee associated with trading before that deadline.
In addition to holding period restrictions, you can also track down the bid-ask spread as another point of reference to determine the liquidity. Wider spreads generally indicate a thinner market which could suggest difficulty in exiting the position. Also, be careful when trading “trendy” funds as they may attract a lot of up front investment, but be difficult to exit if a “flash crash” later occurs.
A prospectus is a dry read for most of us. However, even a quick read can help you make a decision on fees, holding periods, management objectives and the like. I highly recommend doing your research before taking the plunge.
Be Intentional with Your Investments by limiting Taxes and Withdrawals
As you move down the list, make sure you understand what Uncle Sam is collecting for your hard work. Understand the differences between taxes on short and long-term gains, and factor that into your strategy for investing. In general, and depending on your taxable income, long-term capital gains receive more favorable tax treatment compared to short-term capital gains.
Carefully consider putting your investment accounts within an IRA (or other tax advantaged instrument) to further manage your tax implications. In addition, as it relates to retirement accounts, be careful when withdrawing funds prematurely. I recommend carefully differentiating between casual investing via an online brokerage and what you plan on using for retirement. Check out our post on Retirement for more thoughts on the matter.
In all cases, it is important to note that these funds aren’t intrinsically “bad” or “evil” per se. Just be sure to understand what you are buying and how the administration will impact your bank account (in the short and long term).
USE STRATEGY TO BE INTENTIONAL WITH YOUR INVESTMENTS
Don’t chase the markets (unless you are a prodigy of course), and don’t invest emotionally. Set rules for yourself based on your risk preferences and goals. After you have set those rules, try sleeping on them for one night to see if you are truly committed. Then, when the various scenarios present themselves you’ll have a plan to act upon.
Use “The Sleep Test” to be realistic and Intentional with your Investments
Risk is one thing on paper, it is another on the monthly statement. Any one of us might be inclined to invest in a portfolio with strong historical returns and project that steady growth in our our portfolio in theoretical sense. However, the high return might well be accompanied by periods with higher losses. When going through those losses with YOUR money, it may prove to be much less palatable.
Keep that in mind when planning, and ask yourself what amount of loss you could encounter and still sleep well at night. Is it 10%? Perhaps 25% or even 30%? This ties into your overall strategy, and it should be carefully detailed at the beginning. Know yourself, and adopt that strategy – not the one that looks good on paper but ends up making you crazy!
Set Goals and Establish Rules for your Investment Strategy
Each investment, regardless of “fun” or for retirement, should have a goal. If you are investing for fun, just to learn, and experiment, then that should be part of the goal. As an example, I have a small brokerage account that I use for testing ideas and speculating in the market. I could lose every penny in that account and not lose a wink of sleep. The goal of that account is known to me, and I invest accordingly. In contrast, my retirement accounts are strictly reserved for retirement. Compared to the “fun” investing, I go through much greater lengths to carefully research and manage those instruments.
Active vs. Passive Management
Another important pillar in your investment strategy should be approach you prefer to take regarding management. Actively managed funds will generally result in higher fees; passive management is generally the opposite. An actively managed fund might be a good fit you prefer a manager (e.g. fund manager) to monitor and manage the investment. Passively managed funds might include things like ETFs and some low-cost mutual funds. Passive management could be seen as the “set it and forget it” approach to investing. Regardless of the semantics, the important element is the degree of passive or active management you desire.
There is also the opportunity to take a hybrid approach by selecting a few different funds, ETFs, Mutual Funds, etc., and then following those selections for several years (any set amount of time). You could then periodically check-in to rebalance the portfolio, and leave the selection of the funds to once every 5 years (for example). This might help cut-down on higher fees from actively managed funds.
It is also worth noting that some online brokerages offer direct reinvestment of dividends. By directly reinvesting your dividends, the dividend itself is then used to purchase additional increments of shares. If you have this option available, check it out and see what the fees are (if any) before getting started. Regardless of whether or not you prefer active or passive management, if dividend reinvestment is available for a low fee (or even free), this might be a great way for you to grow your position for the long term.
Be Intentional with your Investment Allocations
Now, with your strategy documented and your goals established, take time to consider the allocations of your assets. This process can be made easier by looking at what you’ve already put into your investment strategy and selected for your approach to management.
Think about the horizon of your investing period. If you’re a long-term investor, perhaps consider growth-oriented funds. For those looking for income generation, perhaps funds with dividends or dividend growth makes more sense. The value investing approach is made famous by Warren Buffett and Benjamin Graham, and it is another solid approach to building your portfolio. Another option is to rely upon target date retirement funds. These are setup to shift to a progressively more conservative portfolio as the date of the retirement approaches. However, they can also be more expensive. For some people, the convenience of having the portfolio shift to a more conservative allocation over time (a more passive approach to investing) is with the increased fee structure.
Be Intentional with your hedging
Some of your investment selections should be made because of the augmentation they provide to the overall portfolio structure. As such, they serve to provide protection against certain types of risk. For example, negatively correlated funds can balance exposure in certain sectors.
Additionally, in a general example, within your Roth IRA, you can use TIPS (Treasury Inflation-Protected Securities) and regular, on the run Treasuries to provide some hedging against inflation in your portfolio. You could also consider options, puts and calls depending on your exposure. I would recommend only using these if you’re quite comfortable with what you’re doing. Derivatives can be very helpful to a portfolio, but in the wrong hands (or those without experience), they can be dangerous.
FINAL THOUGHTS ON HOW FIRST-TIME INVESTORS CAN BE INTENTIONAL WITH THEIR INVESTMENTS
Regardless of where you find yourself on your personal finance journey, the key is to keep growing, keep building, keep cultivating Mêtis in your Money Matters.
You’re taking charge of your present and shaping your future and the future of your loved ones. Keep up the hard work!
A Matter of Preference
With investing, much like every area of life, there is a lot of personal preference that can saturate the community. Try to take a moment and understand what you are after, what you need, what you have access to. Then, do some reading in the prospectus to make sure you have an idea about costs and restrictions. From there, you can make a choice as to whether or not the fund, or individual investment makes sense.
If you’re investing for recreational purposes, I recommend setting aside a set amount and then limiting to that. As the old saying goes, “know thyself” and be careful about chasing the market if you’re prone to impulsive spending.
I encourage people to take the approach of a student and make sure you’re learning through the down-turns. Follow your investment strategy and rules (e.g. lock-in gains at X%, cut losses at -X%), and adjust afterward. Soon, you’ll have a fun hobby that (hopefully) makes a little return as well.
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