5 Big Macs Now = 4 Big Macs Later.Module 0: Why Investing Matters.
Welcome! This is the first of 6 (well, kind of 7) quick modules to becoming your own advisor. By the end of these, here’s what you will learn:
Steps to build a financial foundation before investing
All the goods on retirement accounts
Where to go to open brokerage accounts and what products are worth their salt
Understanding your risk and investor profile
Key portfolio building concepts and strategies
Let’s get started.
What is investing?
Investing is about two things: 1) creating wealth and 2) preserving wealth. Growth and sustainability. The first point is what comes to mind first. I invest in companies (or governments, or whatever), these entities create new value, grow, and generate more and more, returning back to me more than what I put in. Simple. It’s also easy to get an immediate grasp of the risk -> some companies fail, and don’t create new value. Output < input. We don’t like those companies very much.
The second point is more elusive and speaks to inflation. We’ve all heard this term, and probably associate with the Fed, or politics, but struggle to make the connection directly to our own lives. The reason is simple -> inflation is a wealth vampire, stealthy, slowly draining your money of its power undetected. For those of us in the USA it’s particularly true, as we’ve seen low, stable inflation over the last 25 years or so. (Inflation is actually good when it’s around this 2% level, keeping the economy fueled and pumping.)
Why does this matter?
Well…the title sums it up in very simple terms. If $20 can buy you 5 Big Macs today, that same $20 can only buy 4 Big Macs a year from now. Your money loses it’s power unless you can multiply it. The real trouble is that keeping your cash in a savings, money market, or even bond fund will only get you about 0.5% or 1% if you’re lucky, well below the ~2% annual inflation rate. => you better find ways to invest that give you more than a 2% annual return, otherwise you will ultimately succumb to the wealth vampire. And that would make for a very lame movie.
What is good?
Now that we have a grasp of the ‘why’, let’s unpack what ‘good’ investing looks like. From above, good investing should accomplish the goals of 1) creating wealth and 2) preserving wealth. Makes sense. But, the other variable here is risk. Let’s understand this with a little field trip outside the world of finance.
My background is actually in Architecture, and there is a saying from construction that for any project, there are three main variables that are in balance – cost, time, and quality (aka the ‘Iron Triangle’ of project management). You can pick two of these. Reducing cost, for example, will stretch out your schedule (less people, equipment, etc) or reduce your quality (same people working faster = more mistakes). This is an exaggeration to some extent, but the analogy is a good one with finance.
We have 1) growth, 2) stability, and 3) risk. Reducing risk can boost stability but decrease growth. Boosting growth increases risk and reduces stability. You get it. What this is really telling us, is that you, the individual, need to find the balance that works best for you, and this all really comes down to your appetite and ability to take on risk. We’ll get into risk in much needed detail down the road, but for now this wraps up our intro here. Not too painful right?
Continue on to the first module to understand the steps to build a solid financial foundation!