The Beginners Guide to Personal Finance & Investing
Simple frameworks and heuristics to begin your journey into personal finance.
What we’ll be covering:
What is investing?
Goal Setting
Money & Wealth
Investing Methods
Stock Investing
🔍 So you’ve decided to become an investor?
Very few things are guaranteed, and turning money into more money is not one of them.
🗂Investor Types
Investors come in various forms depending on the type of assets they choose to invest in and how they choose to invest in them.
Active vs. Passive
Passive Investors:
An Investor who trusts someone or a group to make investments on their behalf.
An example of a passive investor is someone who instead of picking individual stocks based on their own research, invests in a basket of the top-performing stocks chosen by a professional.
Active Investors:
Active investor performs their own research and selects their investments themselves, and are constantly evaluating their portfolios and strategy.
There are different types of active investors, some are professional investors where investing is their full-time job, such as hedge fund managers or institutional investors who invest massive sums of money on behalf of large corporations or employee pension funds.
There's also what is considered the retail investor, who are active investors but not their full-time job.
💪🏼What makes for a successful investor?
The goal of most investors is to have so many successful investments they no longer need to work and live a beautiful happily ever after. However, investing is incredibly hard and takes a lot of research, time, and luck.
The first step in becoming an investor is to produce a higher rate of return than the risk-free rate.
📈 Rate of Return is the net gain or loss of an investment over a period of time.
🎲 Risk-free return is the interest of an investment that provides a guaranteed return with zero risks.
The risk-free rate of return can be considered the interest rate your bank gives you or the interest rate you get when you lend money to the government by purchasing a US bond, which is around less than 2-4%. In most cases, you can lose all your money, and even more in some cases.
So if you can make an investment that gets you above 2% of the money you put in, you are already a successful investor!
🌎Responsibilities of an Investor
As an investor, it is your responsibility to do your own research and not rely on the crowd's thinking when making decisions. Take every piece of information and opinion skeptically and only invest when you have strong conviction.
An investor primarily seeks the best investments that produce the best returns. However, as a member of a greater society, you must consider the social implications of your investments. If you invest in something harmful to society, eventually, that investment will turn sour, and you can lose all the money you made. At the end of the day, all the money in the world will not bring you fulfillment, but the relationships with your family and your community will.
What is Investing Summary
Passive Investors pay someone else to invest for them.
Active Investors do their own research and select their own investments.
An investor measures their performance based on their ability to get a return and beat risk-free rate of return.
Goal Setting
What’s more important?
The Train, The Conductor or The Tracks?
While all three are important to get you where you need to go, the train does not run without tracks.
Your goals and objectives are the tracks. Without a plan or path forward, getting the desired results becomes much more difficult.
How to set your financial goals?
If Money Was Not A Concern, What Would Your Lifestyle Be?
There are very few decisions where money is not one of our first concerns.
Can I afford this? How much money will I make? Will it be a good return on my investment?
We make hundreds of financial decisions, yet we rarely stop to think about how we arrive at them. Most of our economic decisions are not driven by logic but by hope, fear, and stress. Depending on your upbringing and life circumstances, your relationship with money can be complicated and sometimes negative.
“Money is anything that people are willing to use to represent the value of other things for the purpose of exchanging goods and services”.
We forget that money is simply a medium to get what you want.
Step 1: Be clear on what you want and why you want it before even factoring in money.
Tim Ferris implemented this mental exercise he calls ideal lifestyle costing:
The concept is to list and write down your every want and desire, no matter how audacious (🏠, ✈️, 🏎 etc.)
Attach a monthly cost to it
Sum up all the cost to calculate your, Target Monthly Income (TMI).
The number might be bigger or smaller than you imagined, but at least you now have a clear, tangible target. With your TMI set, you have completed the most important task in financial planning, establishing your goals. Now remove the anxiety and create a plan.
Anything is possible.
Here’s a simple template for calculating your own TMI
How much money do you need to retire or stop working?
Everyone has different objectives and standards of living. Warren Buffet is one of the world’s richest men and has lived in the same house for 40 years. Alternatively, I know people who make $60K a year and own a car that costs them $60K. While that’s not something I would do, but if a car brings you joy who am I to judge? The important thing is to understand your goals. That $60k car may bring you joy but may mean you will have to continue to work for a long time to continue to pay for it.
So once you’ve established your TMI, you can quickly calculate the annual cost for your ideal lifestyle.
Step 2: Calculate Target Yearly Income.
Multiply your Target Monthly Income by 12 to get your Target Yearly Income.
💡 Target Yearly Income (TYI) = TMI x 12
Step 3: Calculate your Target Nest Egg
So let’s say you’re TYI is $150K.
If you were to stop working at 60 years old, how much money would you need to save up to spend $150k a year without worrying you will run out of money?
The rule of thumb is that you don’t want to spend more than 5% of your net savings & investments a year.
So to calculate your Target Nest Egg for Retirement
💡 Target Nest Egg (TNE) = TYI / .05
For a TMI of $150K, the TNE would amount to 150,000/.05 = $3,000,000.
So in this example, you would need to save $3 Million until you can retire.
What if you don’t want to retire at 60?
I myself don’t want to work my entire life for the possibility of spending it once I'm old.
Ed O. Thorpe, writer of the best-selling book Beat The Market and legendary investor suggest if you want to be ultra-safe and never run out of money you should only spend 2% a year.
For a TMI of $150k, the conservative TNE would be 150,000/.02 = $7,500,000.
So if you stay disciplined and don’t spend over $150k a year that could last you a long time if you were able to save $7,500,000.
The historical consensus is you should only spend 2-5 % of your nest egg but like everything, these are just rules of thumb.
Goal Setting Summary
Calculate your Target Monthly Income, by defining your Ideal Lifestyle Cost.
Calculate your Target Yearly Income by multiplying TMI by 12.
Calculate your Target Nest Egg by dividing your TMI by a spending rate between 2-5 %.
Money & Wealth
To go forward, we must sometimes go back to have a better understanding.
The History Of Money
“Money is the most universal and most efficient system of mutual trust ever devised”
-Yuval Harari
💲 Money is anything people are willing to use to represent the value of other things to exchange goods and services. Money allows people to compare the value of different goods quickly to exchange them for one another easily and to store wealth.
Before Money: The Barter System
Hunter-Gatherers did not use money. Communities and tribes were small. So everything they needed was traded directly between members of their small groups. Fur was traded for corn or meat for tools.
The Rise of Civilizations and Merchants
As cities and empires grew, so did the need for innovations in the Barter System. Barter economies could not last because merchants have to learn the prices of dozens of commodities, the more commodities, goods, and services in an economy, the more exchange rates you must know. For a complex commercial system to succeed, the butcher cannot know the exchange rate between meat and corn to conduct business.
The Birth of Money
3000 BC, Ancient Sumerians used Barley as money. Cowry Shells are used in Africa, and Cocoa Beans in the Americas
1760 BC, The Babylonians used the silver Shekel not a coin but .3 oz of silver.
700 BC, The Chinese begin to use Paper Money
640 BC, The Lydians minted the first coin and Gold-Silver alloy with a Standardized weight with an identification mark.
Gold Becomes the Global Currency
As civilizations continued to trade, Gold and Silver began to take immense position as the universal money of the world. European monarchies and merchants began to scour the earth to find Gold and Silver.
The Evolution of Money
1700s, Banks, and governments began to issue banknotes and paper currencies backed in reserves of gold
1971, President Nixon removes the US Dollar from the Gold Standard, making the US Dollar effectively worth the belief in the US economy
2009, Bitcoin is created, ushering in a new type of money, cryptocurrencies.
The Global and Banking Financial System.
Today most government currencies, including the US Dollar are Fiat Currencies.
💲 Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by trust in the government that issued it.
In other words, much of the value of government currencies is based on the trust of the economic and military power of the government.
How Your Bank Turns your $100 Deposit into $200.
Cash Back. Airline Miles. Free hotel nights. These are just a few of the hooks banks use to encourage you to sign up for their credit card.
How profitable can credit cards be for banks to offer such amazing benefits?
Banks offer you so many rewards because the money they lend you is created out of thin air.
When you deposit $100 into a checking or savings account, the bank keeps that amount as a liability they owe to you, but then flip that $100 into $1000 of lendable capital. This is called fractional reserve banking, where the bank keeps a fraction of the deposits they collect and leverage those deposits into the capital they lend out.
They take your $100 deposit, then lend $1000 to someone else who just charged their vacation on their credit card. The bank can then charge 20% interest, making $200 off your $100 deposit.
If you’re lucky the bank pays you 1% interest on those $100, which is less than the average rate of inflation of 2%. You lose money while the bank earns double what you put in deposits. On top of that banks charge you all sorts of fees for using their service.
Investing Frameworks
If you are new to investing, here’s a simple framework I use to evaluate the the types of investments you should make.
TERF:
Time Horizon ⏰
Is the time you expect to hold on to an investment.
Are you investing for retirement? Are you investing for a down payment on a house?
Depending on how long your time horizon is will determine how much risk you can take and the types of investment you should make. If your horizon is years away, you might want to consider high growth opportunities. If you need the money within the next 2-5 years you might want to invest in assets with less risk and are easier to liquidate.
Effort 💪🏼
It’s important to be realistic on how much time and effort you’re willing to put into researching potential investments. If you live a busy life and can only commit to an hour a week, you might be better off investing in ETFs or Mutual Funds. If you’re interested in day trading you’re going to need to devote hours a day just for research.
Risk Tolerance ⚠️
How much money are you willing to lose? If you lose this money will it make you a miserable person to be around? Can you handle violent swings in your portfolio? The ability to handle and cope with risk are key factors you need to consider when investing.
Focus 🔍
Figure out what you enjoy investing in and where you have some level of expertise. Your insights and knowledge will compound over time giving you an advantage in the marketplace. If you’re an engineer invest in technology. If you’re in the healthcare industry invest in healthcare. Use your strengths to your advantage.
Investing in Stocks
What is a stock anyways?
📈 Stocks are tiny pieces of ownerships of a company or corporation.
📈 Stock markets are exchanges where you can buy and sell shares of companies publicly.
Why should you invest in stocks?
For the last 100 years the S&P 500, An index of 500 of the largest publically traded companies in The US, have returned 10%.
In other words investing in the biggest companies built here in America have been a great opportunity for investors to generate wealth. Specific stocks in companies may go up and down or even fail but the US market overall always rebounds and continues to grow.
What is an ETF?
An ETF is a basket of securities that are bought and sold on a securities exchange. It’s a way to buy and sell a group of assets.
An example of an ETF is the SPDR S&P 500 ETF, which invests in the top 500 companies listed by the S&P Index, or Invesco’s QQQ which invests in the top 100 companies in the NASDAQ.
Over the years ETFs have become more popular with investors. It allows investors to reduce their risk by not putting all their eggs in one basket, while not having to pay so much in fees for someone to manage it.
Most people don’t have the time or knowledge to invest in the stock market so it’s easier to bet on the stock market, than individual stocks the overall market has returned an average of 10% a year since the 1920s.
It’s a low-risk, safe bet.
Why would I invest in stocks if they go up and down, but the cash in my bank account stays the same?
The answer is because of Inflation.
📈 Inflation: A general increase in prices and a fall in the purchasing value of money.
The money you earn and save in your bank account loses its value as the goods or services you buy get more expensive each day.
What causes inflation?
The law of supply and demand states an increase in the money supply SHOULD cause the value of money to fall. Modern currencies have consistently continued to lose value since the great depression. That’s why your grandparents paid a nickel for a Coca-Cola.
Central banks, like the Federal Reserve for the US, determine how much money is printed each year. The Fed believes that a 2% inflation rate is healthy for the economy to grow. Whether 2% is healthy or not is debatable, regardless it’s not enough where it makes it difficult to conduct commerce or plan for the future.
To this day we yet to have a good understanding of inflation.
To combat the economic declines during the great financial crisis of 2008 the Fed increased the money supply for over a decade and no significant inflation was noticed.
20% of the USD money supply was printed in 2020 alone for COVID relief which cause an inflation rate of around 8-9% in 2022.
The mechanics of inflation are still unknown but one thing is for certain, the cash you save is depreciating. The values of currencies are mostly in the hands of central bankers and the policies of politicians across the world.
Investing is not just for building wealth but preserving the earnings you made through hard work. Start Investing now, your cash is melting.
Three Simple Tips to Get You Started on Investing
Finance and investing can get complicated. Here some simple ideas to get you started:
1. Pay Yourself First.
We all want to save more money than we do, but life gets in the way.
A simple way to save is to set up automatic deposits to your savings or investment account as soon as you get paid. If it’s set aside, then you can’t spend it.
2. Time in the Market is More Important Than Timing the Market.
The market is unpredictable, and very few people in the world can predict the ups and downs of the market. However, since the 1920s, the S&P 500 has returned an average of 10% per year. It’s better to play the long game and ignore the daily mood swings of the market.
Invest in great company. Lock in those gains. Stop trying to become an oracle.
3. Pay the premium for winners
A real estate investor once said, “Someone in the 1970s believed the real estate prices in New York City or Beverly Hills was too expensive”. In the long run no matter how overpriced an investor paid for a property in NYC or LA back then, today it would still be a great investment.
10 years ago I thought the Apple Stock was too expensive, but if I would’ve invested I would’ve returned over 10X of my investment by now.
When it comes to investing, real estate, and talent the winners are always worth the premium.
