3 Key Personal Investing Decisions
Writing down personal financial goals is an important step to take. A good plan requires a starting point and a place to go. However, things can get confusing once you move from planning to doing. Today we have many different options available for investing money in support of our financial objectives. I don’t intend to cover the multitude of choices here but will instead describe 3 key personal investing decisions you could be facing even now. Consider this post to be a small scratching of the surface.
1. Invest in the stock market?
The most fundamental decision to be made is what to do with income that exceeds expenses. As mentioned above, there are many options for today’s personal investor. Stock market, real estate, crypto currencies, precious metals, savings accounts, sports cards, fine art, glass jar in the backyard, etcetera. This post will focus on the decision to invest or not in the stock market. For most personal investors, this decision will boil down to a question of risk tolerance and time horizon.
Risk tolerance is a subject that can be a bit trickier to consider than it seems at first pass. Intuitively, one may have the impression that investing in the stock market is riskier than saving money in an FDIC-insured savings account. That isn’t necessarily wrong…but it isn’t necessarily right either. Savers and investors can sometimes forget about inflation as a risk-generating force. For example, if the rate of inflation exceeds the interest rate earned on a savings or checking account, the holder of that account is losing money in real terms. It is certainly true that stock market results from one year to the next can vary…significantly. Just don’t forget about the risk of inflation when making your decision.
I mention time horizon as a factor separate from risk tolerance but in reality, the two are highly related. Personal investors are much more likely to earn the best returns in the stock market over longer period of times. Investing money you need in the near-term is risky. Forecasting when to “time the market” with investments is probably not a great approach (forecasts are lucky or lousy after all). Better that you: determine how investing ties to your life goals; understand the time horizon to achieve those goals; assess the options available to you; and then account for variance.
Variance Over Time
As an illustration of variance over time, let’s look at the stock market’s annualized returns (Compound Annual Growth Rate or CAGR). We’ll use the S&P 500 as a proxy for the overall market. The below information includes dividend returns.
This picture tells a story of solid returns through investing in the S&P 500 over time. Good for you if you were lucky enough to start investing right after the Dot Com bubble burst. You would have earned higher returns than if you started investing just before. However, the difference is not monumental. In fact, assuming consistent investment was taking place throughout 2000 through 2003, returns over the next 19-22 years have been quite nice.
What if someone invested at the start of 2000 despite needing the invested money by the end of 2002? That story is not as nice. Every dollar invested under those circumstances would have become a paltry, inflation adjusted $0.58 (-16.7 CAGR assuming the investment was liquidated). We will find many other cases where investing/selling over a three-year horizon would have been a very profitable endeavor. The last 3 year (2019-2021), as a matter of fact. I suppose gambling can be interesting. I think I prefer the odd trip to a $10 Blackjack table.
2. Go it alone or use a financial advisor?
Assuming you determine that investing in the stock market is at least one viable way for you to support your life plans, should you go about investing on your own or enlist the services of a professional financial advisor? In my opinion, the best answer is “yes”. Choosing one or the other option need not preclude the other choice. Working with a professional financial advisor and investing on your own are both ways to learn about investing while you put your plan into action.
Professional Financial Advisors
There are many choices in the world of professional financial advisors. I’ve had the good fortune to work with some good ones at Merrill Lynch and Fidelity. My suggestion is to talk with people you trust and see who they trust in the industry. Talk with prospective advisors about your plans and goals before you make a choice. Make sure you understand the resources and expertise they bring to the table as well as the costs and constraints of their services. You may be able to manage your banking, retirement accounts, educational savings accounts and more with the same advisor and their platform. It’s a good idea to regularly assess whether the arrangement is still providing you with value.
Do It Yourself
Similarly, there are many “do it yourself” investment platforms to select from. Online banking and investing are so convenient and commonplace, I can’t recall the last time I set foot in a physical financial institution. Even powerful investment screening and modeling tools are available – right on our phones! These platforms will very likely be less expensive than engaging with financial professionals, however, it will be incumbent on you to do the research and find the resources you’re looking for. I have used E*Trade for over 20 years now. The platform has met my self-investing needs and has evolved favorably over time. My kids even have their own E*Trade accounts now and we use the platform as a means of learning about saving, spending, and investing.
We’ve all heard the adage “don’t put all your eggs in one basket”. By choosing to both engage with a professional financial advisor and invest on your own, you can at least have two baskets to put some [nest]eggs into. But where to get started with your own stock market investments?
3. Individual Stocks or Mutual Funds or ETFs?
If we’ve made it this far into the post, I’ll make a presumptive leap that you are not looking for information on options trading strategies. That might be a poor assumption. If so, here is an excellent Investopedia article that should help scratch that particular itch. If instead you are looking for something more foundational as a starting point, I hope this helps.
You’ve made the decision to invest in the stock market and to execute at least some of your investment strategy on your own, through a platform like E*Trade or TD Ameritrade. Do you want to invest in individual companies? What about mutual funds and exchange traded funds (ETF’s)? Perhaps the most straightforward way to think about these three types of assets is to consider what you are betting on when choosing to invest in one or all of them.
Individual Stocks
When investing in the stock of an individual company, you are essentially betting on better than market results for that particular stock. I’m setting aside the fact that you can short sell or buy a put option for the purpose of this discussion. There are many reasons you may be optimistic (“bullish”) about the prospects of a particular company’s stock. Research and data analysis can help, but in the end the investment decision comes down to your belief in the market’s assessment of the company’s stock over time. Individual stocks are bought and sold within each open trading day.
ETFs
Exchange Traded Funds or ETFs consist of a mix of different assets which represent a greater level of diversification as compared to individual stocks. ETFs tend to track market or specific sector indices. In this way, investing in an ETF might be considered to be a bet on the market as a whole (or at least a particular sector of the market). While there are more actively managed choices available today, in general, ETF’s will have lower fees than mutual funds. This is because they tend to be managed more passively as they seek to replicate the performance of the market or a portion of the market. Like individual stocks, ETFs are bought and sold within each open trading day.
Mutual Funds
Mutual funds, similar to ETFs, also consist of a mix of different assets. Historically, mutual funds have tended to be actively managed, meaning fund managers make frequent decisions about how to change the allocation of assets within the fund. In this way, investing in a mutual fund might be seen as a bet on the fund manager’s ability to mix assets to beat the performance of the overall market. More recently, mutual funds that are passively managed (i.e.: seeking to replicate the market or a portion of it) are available to investors. Generally, mutual funds will have higher fees than ETFs, but it really comes down to the individual funds. Unlike stocks and ETF’s, mutual funds can only be purchased at the end of each open trading day.
Small, Consistent Steps
Every journey starts with a single step. Deciding to invest money is a big first step. You will make mistakes. I certainly have made them along the way. However, you can mitigate the impact of mistakes by investing in small, consistent amounts over time. Non-catastrophic mistakes make for better learning opportunities than do successes. Regularly check how things are going and adjust your plan. Just remember that the sooner you take that first step, the easier it will be to make course corrections.
Some examples of small, consistent steps: contribute to a 401k plan every paycheck (a very good idea, especially if your employer matches your contribution); establish quarterly automatic contributions to your child’s 529 educational account; and increase your investments with every pay raise or new source of income.
Financial market variance is a fact of life. Don’t find yourself having to make wild changes in direction in order to adjust to it. Create and manage your plan.
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