MoneyMonday: Money In Motion: Basics of Investing

Welcome to this session, Money in Motion – the basics of investing. I’m Janel Cross.

We think of your financial life as unfolding in three stages. The first is Financial Safety with a focus on building a good foundation. Next is Wealth Accumulation where we gather resources for the final stage, and Financial Freedom where we have the money and resources, we need to do the things that bring joy and fulfillment to our lives. For more on the money stages, check out our Money Milestones course which takes a deep dive into each stage.

This session is considered a core course for anyone at any stage.

Between big words and investment jargon, investing can be intimidating. But it is actually NOT rocket science…

So long as you keep it simple which is precisely what we are going to do today.

Let’s start with the difference between stocks and bonds. Both are transactions between an investor and an entity. The entity is commonly a corporation but can be a government or municipality. Today, we’ll stick with a company as our entity.

Let’s say the company needs to raise money to expand operations. They have two options for raising money (or capital as the investment gurus would call it). They can issue stocks or bonds.

In a stock transaction, the investor exchanges money for ownership shares of the company called stocks. The ownership is recorded on a stock certificate.

In a bond transaction, the investor isn’t buying ownership rather they are making a loan. The company promises to pay the investor back at a future date and pays interest between now and then.

So which kind of investor do you want to be? Let’s consider how stock investors make money (or as the gurus call capital appreciation).

Ideally, the company you invested in grows. Perhaps they brought a new product to market or acquired another company. Or maybe the economy has been strong, and they are simply more profitable. That success is reflected in a higher price for their stock.

Let’s say you bought your ownership share for $10 and now it’s worth $100. You could list those shares for sale. And, if you can find another investor willing to buy your ownership stake for $100, you will have generated a $90 profit or capital gain.

Sounds good, right? So, what’s the risk of losing money? Let’s say the company is sued over a faulty product… or it’s 2020 and COVID takes over the world. If the company’s profits shrink, the value of its stock could go from say $100 to $10. And if the investor sold their ownership now, they would lose $90

Because of the risk associated with stock investing, we consider stock investment the long game. To illustrate why let’s look at the Dow Jones Industrial Average. This is what we call a stock market index. Simply put, it’s a group of 30 companies. The combined value of this stock basket is reported daily and helps investment gurus keep a pulse on markets and economies. If you owned a basket of Dow Jones companies between 1/3/2017 and 12/31/2020, your investment would have grown from 19,881 to 30,606. You’d be pretty happy with these results for a four-year commitment. The challenge, however, is that the stock price didn’t go straight up. In fact, investing in the stock market can feel like riding a roller coaster.

If the ups and downs of the stock market make you queasy, you might consider the bond market. Remember, a bond investor is more like a lender to the company and the company pays the bond investor interest and makes a promise to pay back the loan at some future date.

Buuuuut, the bond market isn’t entirely without risk. Like stocks, bond earnings are dependent on the success of the company. If the company isn’t doing well and can’t afford to make their bond payments… or worse, if they go bankrupt… the bond investor can lose the money they invested.

Even if your company continues to make its bond payments, the economy and Congressional action can impact the value of your bond investment. For example, if interest rates go up, that means a company issuing a new bond must pay more interest to investors. And, if you are invested in an old bond paying a lower interest rate, the value of your investment may go down.

So, with all those risks out there, obviously picking the right company is important. But how do you know which ARE the right companies?

• Is it Lowes or Home Depot?
• Will Tesla be the most profitable electric car company next year or will fast-growing NIO outpace them?
• How about choosing between Apple and Microsoft?

What about the thousands of successful companies you’ve never heard of…

Mutual funds are an investment product managed by a team of investment professionals who make it their life’s work to find the right companies.   Investors make investments in the fund and the portfolio managers select the stocks and bonds they believe will prove to be good investments.

As a mutual fund investor, you own a piece of the entire basket of investments. And by owning lots of companies, you increase the odds that you’ll own some big winners, and you decrease the impact of owning a few losers too.

This is called diversification.

Each mutual fund has a specific objective that defines the types of companies the managers invest in. These groups of companies are called asset classes.

There are large companies and small companies. There are companies based in the US and companies based all around the world.

In fact, there are multiple stock and bond asset classes.

Each of the colors in this chart represents a different asset class. Each column lists the asset classes from highest returns to lowest returns by year. You’ll notice that the colors at the top – the winners – and bottom – the losers – are different each year. Which means that there is no single best asset class.

The best way to reduce the risks of investing in stocks and bonds is to diversify. The more types of companies you own and the greater the number of companies you have in each asset class, the less risk you have of any one company performing poorly.

The amount of risk your diversified portfolio has is based on the size of each asset class slice.

So, bonds are more like a kiddie coaster whereas international emerging market stocks are more like a super duper looper!

For any investment, though, the most important thing is to stay the course. Like all roller coasters, every investment goes up and down. And just like you wouldn’t release your safety restraint midway through the coaster ride, your discipline to stick with your investment strategy in both good and bad times has a significant influence on how much wealth you can build.

Staying the course, though, is easier said than done. In fact, humans are emotionally wired to do the wrong thing at precisely the wrong time.

As the market goes up, so does our confidence. In fact, we typically feel the best about investing when prices are at their peak.   And, while it’s not obvious, this is when risks are highest.   But what goes up must come down. And as market returns decline, so too does our investor confidence which typically hits its lowest point at the best time to buy.

This is the emotional roller coaster of investing, and it can be a costly ride because we feel the best about investing when prices are highest and hesitate most when investments go on sale.

There are lots of resources in MoneyNav to help you better understand market volatility, so we’ll just keep it simple here… Ignore the news and don’t panic.

From January to July 2020, 91% of news related to Covid was negative. Compare that to 54% in the foreign press and 65% in scientific publications.

And while these have most certainly been scary times, they aren’t the first scary times we’ve faced. In fact, the -34% Covid decline wasn’t even the worst we’ve seen.

Despite seven periods when the market went down by more than one-third, investors who stayed invested have been rewarded. A stock investor would have seen their $10,000 investment grow to nearly $4M. An investor who spread their dollars between stocks and bonds built over $2M in wealth. Even the slow and steady bond investor would have seen their account grow to nearly $1M.

But the investor who panicked didn’t fare as well. One quick note before we head toward the end of this discussion. This orange line reflects the growth of money left in the bank. While we’ve spent a lot of time discussing risks, leaving money in the bank probably won’t make your retirement dreams come true.

So, best to focus our energy on managing and navigating risk than avoid it altogether.

As you saw in the last slide, money can really grow if we don’t let our emotions get in the way. But the other major factor is how long we let those dollars grow before we spend them. So, the most important thing you can do is to START. Just start investing in something. And if you’re already investing, try to invest a little more every year.

Whether that’s adding 1% to your 401k savings rate or investing part of your tax return in an IRA, the more dollars you invest and the longer you keep them invested, the more likely you are to experience success.

Then just keep taking the best next step. Google is full of advice. So are family and friends. But not all advice matches your situation. We are here to help you figure out what the best next step is for YOU, right NOW, so you wind up where you want to be.

A great next step is to complete your MoneyNav assessment. This questionnaire takes about 5 minutes and results in a series of To Dos, or best next steps, that are built into your personalized MoneyNav dashboard. For a link, email yourfinancialcoach@moneynav.com.

Hopefully, you now understand the difference between a stock and a bond and know what you can do to be a successful investor. You can find more information about investing and other financial topics at moneynav.com. Thanks for listening. And I’ll bet your future retired self thanks you too!