Four-part Series on Investing Basics

Easy to Read for the Absolute Beginner and a Refresher for All

Part I: Words to be Financially Wise:

The Power of “Overlooking.”

My introduction into the strange world of personal finance came from misleading promises of two insurance company annuities. The early growth of the annuities returned 12% a year but dropped to 3% without any explanation. Then I was confronted with surrender fees of $6,000. I felt ripped-off; and then had to listen to insulting remarks from an insurance agent who rebuked me and my education colleagues and to me by lecturing, “I’ll never recommend mutual funds to teachers because they are too risky.” I ended our “discussion” immediately and began looking for alternatives. (Mutual funds will be discussed in details in Part IV.) But I needed to learn the basics myself and for my educational colleagues. After researching the most well-known investment options, I created the following table to help all of us make sense of the investment choices available.

Fortunately, most of the financial industry’s offerings can be safely ignored. Let’s break this down into three basic groups.

 

Savings. Many Americans have one of the savings accounts listed. Unfortunately, millions of Americans have all of their money languishing in these savings accounts, Certificates of Deposit (CD) or Money Market accounts. Stay away from Annuities: they are inherently bad investments due to their complexity and high costs (see “Annuities: Useful But Little Understood”).

Financial news outlets report 2-3 trillion dollars in money market accounts. A wise investor doesn’t invest 100% in any one investment. The standard interest rate for money market accounts offers dismal returns, which does not keep up with the standard of living. Over time, inflation erodes buying power (See my previous article on the monopoly of annuities in K-12 school districts).

People keep money in savings for good and bad reasons. Good reasons are sensible amounts available for emergencies or saving towards a home or auto down payment. Bad reasons are a knee-jerk response to the 2008 stock market losses, misunderstanding risk and missing out on the growth benefit of long-term investing.

        “Speculation/Gambling” is straightforward. I see speculation and gambling, as the taking of excessive risk in an almost desperate attempt to get rich overnight. Gambling is understood by most as a 99% self-destructive habit and a negative (and expensive) form of entertainment. Few industry experts can adequately explain to me, beyond a reasonable doubt, a solid reason for taking on excessive, speculative risk in investing. Hedge funds, derivatives, private equity (See Department of Labor) and the current fad among brokers: selling private real estate investment trusts (REITS) are all dreadfully costly. Your money is locked up for years. They are also complex, too risky and their returns have lagged the market averages.

The wisdom of owning individual company stocks and gold is debatable. Most prudent financial advisers recommend owning all available companies, not just one or two stocks. If your company offers a 401(k) match of purchasing the company stock, take the offer. But as soon as you are eligible to sell the stock, reinvest it in your diversified portfolio plan (Article about the cons of owning your company’s stock).

For my comfort level owning stocks in all available companies reduces the risk by increasing diversification. Investing 100% in any one company (or that savings account) is equivalent to the adage of “putting all of your eggs in one basket.” The goal is to diversify across thousands of companies located in hundreds of countries worldwide.

I like to wear a gold watch, a gold wedding ring and even gold in my eye ware. It’s pretty and shiny, but those eye-catching images are not legitimate reasons to own gold as a separate investment. Thus, the entire gambling/speculation group should be ignored–excessive and inexplicable risks does not make financial sense.

To summarize, don’t invest in:

• One company, no matter how big or famous: Apple, IBM, Microsoft, Tesla, etc.
• Your friend’s boutique or his investment recommendation
• Something you don’t understand
• Gold, silver, visual art and diamonds (Only for pleasure)

The art of being wise is knowing what to overlook. Psychologist and Philosopher, William James

Thus, the middle column above shows you what to ignore, which is the primary idea for Part I of this series. Knowing what to ignore is a significant development in your working knowledge of the financial industry as we move forward in this series. It reduces the industries’ complexity and all of the incomprehensible jargon. Overlooking will guide your thinking to where you should invest.

          Focus on the Third Category, Investments. Knowing where to put your money with just enough risk and sticking with the plan is the challenge and the goal of investments. Financial institutions provide excellent models that we can copy when we set up our plan: university endowments, pension plans (My pension: California State Teachers Retirement System) and the Bill and Melinda Gates Foundation invest in the third column in the above table. It is appropriately titled “Investments.” Real estate investments are a crucial choice for financial institutions and homeowners. People are not afraid of owning a home–it is a long-standing American tradition. The inclusion of stocks and bonds in our retirement plan has been problematic for most people. Financial institutions have a long tradition of investing in real estate and stock and bonds. Why not us too? Discovering and managing our diversified portfolio of stocks and bonds will be the focus of the rest of the series.

This first step in learning about investing is unlearning. Ignore the nearly universal opinion that it’s too complex. As you discover what to ignore, your target for investing is easy to grasp. When you look for investments that grow side-by-side with the economy, you’ll see the benefits of investing in the total growth of the world’s economies. Discovering investing safely in those sometimes “dreaded” stocks and bonds is not as complex as you think. After reading this four-part series, you will enjoy financial security.

Part Two in this Series on Investing Basics will include:

• Introduction to the stock and bond markets.
• Understanding stocks and bond asset classes for diversification.