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Investing 101

Simple ways to achieve financial tranquility.

A few weeks ago, I wrote a Twitter thread on ways one can generate income streams.

To expand on this topic, I want to share notes on how to approach basic principles of investing.

Note: this essay is aimed for people just starting in their investing journey.

Savings

Perhaps the best thing one can do is create a “personal P&L” that they review monthly. This is personal financial statement report helps you balance your budgets and identify spending areas. There are plenty of apps ranging from Mint to Personal Capital that can help here. I use a spreadsheet to keep track.

Let’s discuss savings for a moment. Savings is a concept taught by our parents. It was taught by their parents and so on. It’s important to save, but the way we view savings has to evolve with the times. During the 1990s, banks were giving 6-8% CD interest rates on saving accounts. It was a safe place to park your money and earn something on top. Today, that number is ~0.01%. Banks leverage your money to make money on top by lending it at much higher interest rates. It’s the ultimate arbitrage. 

My quick take on savings is the following: aim to have 3-6 months of living expenses saved. Try to save 15-20% of your monthly income, if possible. Call this your rainy day fund. Don’t touch this and leave it in a savings account. For some, this number is 3 months; for others it’s 9 months. Everyone is different. A rainy day fund will protect you and your family from any unforeseen circumstances.

Invest the rest. More on this below.

Historically, inflation rates have hovered around 2% per year. Your cash needs to try to keep up with inflation, so a good place to park your money could be in money market funds. It’s liquid and easily accessible. Just like a savings account. It may not give you 2% exactly, but it’s surely better than 0.01% that a standard savings account provides.

As you progress through your journey as an investor, you’ll start to evolve your relationship with money; in particular, with how you view cash as an asset and a medium of exchange. This will range from managing your liquidity, having a personal revolving line of credit, leveraging strong banking relationships, and so on. But that’s a topic of discussion for another day.

Capital Markets

I recommend low cost index funds. If you’re unfamiliar, here’s a quick overview.

Index funds are a basket of stocks that you can own. Example: S&P 500 is an index. It includes America’s top 500 companies. You can buy into those 500 companies at once through an index.

You buy an index fund via an exchange traded fund (ETF) or a mutual fund. Consider these as “vehicles” to purchasing an index fund. Key difference between the two:

  • Mutual funds are actively managed by fund managers. They typically cost more to manage. 
  • ETFs are passively managed. They track a specific index and cost less.

I like ETFs more. 

You can truly diversify your portfolio with these vehicles and get as much or as little exposure as you like. 

Two things to look for when you’re buying: 1) expense ratio, 2) historical performance. Reflect on both when evaluating either vehicle. Mutual funds, in particular, are more expensive, so pay particular attention to that.

Here’s a list of low cost ETF for your reference.

You can still buy individual equities if you like. I do. But be sure you manage your risk accordingly. Individual equities can be volatile and may require active management. 

If you’d like exposure to bonds or other fixed income securities, ETFs are a good way to buy into them. A bond ETF could contain hundreds of bonds, which makes an ETF less risky than owning just a handful of individual bonds.

Key takeaway: diversification is key. The broader the exposure, the less volatility you’ll experience. You don’t need to day trade or actively manage your portfolio; be patient and allow compounding to work for you. To better understand risk management and diversification, I discuss “unsystematic risk” at length here.

As you progress through your investing journey, you’ll start to seek asymmetric investing opportunities, where potential upside outweighs potential downside. This is a good thing; you shouldn’t avoid risk in life. You should learn to manage risk. When reflecting on such opportunities, be sure to do your own due diligence; FOMO investing isn’t a strategy. People are always seeking alpha. You should, too. Just make sure you understand the risk factors.

Real Estate

Depending on your stage in life, you might be ready to buy a home. If you’re already a homeowner, then you might consider adding rental property to your portfolio.

In either case, I recommend owning real estate if you have the means. 

For people interested in real estate investing, it has three key benefits:

  1. Your property appreciates over time.
  2. It’s tax deductible.
  3. You can generate cash flow.

Let’s look at an example. 

You buy a rental property that has a PITI (principal, interest, tax, insurance) of $1,000/month. This is effectively your mortgage. You’re able to rent this property for $1,600/month. You hire a property manager to oversee the property. You pay them 10% of your monthly rent per month. Your monthly cash flow on the property is $440.

Not bad. Your mortgage is getting paid by your tenant. You’re able to write off the interest expense and any work done on the property for tax purposes. And you’re generating some cash on top.

In the future, if you decide to sell it and buy another property, you can do a 1031 exchange. You can defer your cap gains tax obligations and roll the funds into another property. This provides flexibility for investors. You can learn more here.

Real estate has barriers to entry, though. It’s expensive to buy (down payment), you have to have a great agent, good lending relationships, etc. Unlike capital markets, it’s a hard asset. But if you have the means, this is a great asset class to have exposure in.

Bitcoin and Digital Assets

We’re living in a new world order. Digital assets are likely here to stay.

Bitcoin (BTC) is probably the best blockchain application we know today. It’s a volatile yet an appreciating asset. Unlike USD, which in its current form, is a depreciating asset. I discuss recent liquidity trends by the Fed here.

I made a case for BTC here and here

If you have the means and the risk profile, then it might be a good idea to have some exposure in this asset class. 

Living Trust

Life can be unpredictable. You have to plan accordingly. I recommend setting up a living trust. This will give you peace of mind knowing your estate is set up properly. 

Here’s a list of things to do when setting up a living trust: link.

Charity and Philanthropy

Giving should become an important part of how we lead our life. My framework for charity is giving a certain percentage of my savings and liquid financial assets that are not used towards my living expenses annually. I donate to causes I care deeply about. They range from education to solving for hunger. This works for me and meets my goals.

You might have causes that you care deeply about. Identify organizations that are helping address those issues.

Charitable gifts you make to a 501(c)(3) non profit is considered to be tax deductible. Besides solving immediate and long term needs, there’s an added benefit for people that are charitable.

Life Goals

Financial tranquility comes from setting simple goals and working towards achieving them. This includes things like saving for a house, kids college tuition, vacation funds, retirement planning… list goes on. 

There’s no one size fits all equation. Just remember that investing isn’t hard, but requires discipline. Focus on making it work for you.

Note: I am not a financial advisor. Everything shared in this essay stems from my experience and in speaking with other experts. Investing can be risky. Please consult your financial advisor before investing.

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