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Investing Basics

Investing Basics

A basic understanding of investing is crucial for financial planning. Nurtured with patience and discipline our investments grow steadily over time, thereby strengthening our pillars. In contrast, poor investing decisions undermine our pillars and imperil our financial priorities. If you find the topic confusing or intimidating, rest assured—it needn’t be. You can achieve all your household objectives by self-identifying as a passive investor (discussed below) and following simple mechanical processes.

 

Expected Return and Risk

All forms of investment: in stocks, bonds, real estate, etc., are undertaken with the objective of obtaining some positive gain or return. In seeking these rewards we must accept some risk, where risk is defined as an activity that yields uncertain outcomes with potentially negative consequences. No conversation about investing is complete unless it simultaneously considers:

  1. How much risk is involved, and
  2. How much reward or return is expected

Sellers of financial products and services invariably try to get you to focus on one or the other. They try to tempt you using the “greed” motive by focusing on rewards or returns, or they try to scare you using the “fear” motive by focusing on risk. You must always insist on considering both together, in balanced fashion. 

 

Follow a Passive Investing Strategy

One of the decisions you must make is whether to pursue an active or passive investing strategy. If you are reading this Getting Started section, you should be a passive investor. A passive investing strategy invests in indexes (or portfolios) of stocks such as the S&P 500®—a portfolio of large American firms. Passive investments require no in-depth analysis, incur few trading costs and have low management fees. They also tend to trigger few taxable events.

 

Assemble a Passive Investing Portfolio

Creating an investment portfolio is mostly a mechanical process comprised of several distinct steps:

  1. Choose an investment strategy: passive or active (passive is assumed hereafter)
  2. Allocate money to asset classes (an asset class is a collection of assets that share certain risk and return characteristics) 
  3. Select specific investments within each asset class (invest in stock and bond mutual funds or exchange traded funds) 
  4. Monitor & rebalance your investment portfolio (typically on an annual basis)

The links above take you to investing basics content in e-Book 1

A deeper discussion of investing may be found in e-Book 3, along with specific examples of funds you may wish to consider for your passive portfolio. 

 

The Three-Fund Portfolio

If you want an even simpler solution, you can embrace some version of the Three-Fund Portfolio, in which your investments are directed to just three highly diversified funds, each of which invests in thousands of stocks or bonds:

  1. A diversified U.S. stock fund
  2. A diversified U.S. bond fund
  3. A diversified fund of international stocks 

Some investors add an international bond fund, a TIPS fund for some inflation protection, and/or a Real Estate fund.

The main takeaway here is that you can cover your investing needs with simple, easy to understand and implement solutions. This gives you more control and allows you to avoid paying unnecessary fees to advisors, many of whom would simply implement passive investments on your behalf.