What Should I Invest In? Assets!
Why Should I Invest? Future Cash Flow!
Everyone is an investor. Whether or not they are aware of this fact is an entirely separate topic. Regardless, we all invest, all the time, across a wide ranging spectrum of investment opportunities, but we also, only invest across only 3 macro investment options. Consider the Dalio quote above, if investing is a play for cashflow, and considering the sources of cashflow being income, then the 3 types of income are the only 3 investment options available:
Earned Income = Investing in Employment (high tax)
Portfolio Income = Investing for Capital Gains (mid tax)
Passive Income = Investing for Cashflow (low tax)
That simple. Only 3 investment options. More detailed context on all 3 in the Income Section. In this section, we are focusing on the context of investing, the context of the big game.
The only sure way to win the Equity Game is by investing in Assets, with one simple goal: to make you more money in the future.
What does this mean? and what’s the purpose of having more money in the future? The purpose of investment should always be so you don’t have to simply sell your time for a living, so you have more time to do what matters to you, even if that means working/employment, it’s done on your terms. This win scenario of freedom of time is also called 'retirement'; most people do it when they are 65, but there are also some of us who figured out how to get there much sooner, we’ve freed up our time, and spend it doing what we really want to be doing.
Investing can be a very complex subject, it doesn’t have to be, regardless of the depth of your investing IQ, your investing fundamentals should always be simple enough to be understandable. If you’ve been investing for a while, or whether you're a total beginner, establishing solid fundamentals is always an essential act, we recommend you do so on a regular basis to insure your returns are consistent with your goals.
This section of the framework is segmented into 3 primary parts, review them thoroughly and regularly for optimal performance.
Section 1: Fundamental Concepts
Section 2: Basics Principles
Section 3: Investment Selection
Part 1: Fundamental Concepts
Future - Investing is all about the future. Your future, the future of progress, the future of innovation, the future of society at large, and so on. Just because a company performed well in the past doesn’t mean it will be relevant in the future, and just because past performance of an asset is known to do well, doesn’t mean it will necessarily be the case 10 - 20 years down the line. When investing your money, you are both expecting future returns, and you do so by anticipating future performance, whether it’s a city you choose to buy some real-estate in, or a sector of the market you are picking stocks from, investing is all about the future, not about the present, and certainly not about the past. So, when you’re thinking of investing, always ask yourself: "is this investment I am making going to preform well in 1-5-10-20+ years?"
Risk - Whenever you're investing, always asses the downside! Ask yourself, "What is the worst that can happen?”, “How can I protect myself from the downside?”, “What are the ways you can lose (as in 100%)?” Investing should not be treated as gambling, and speculation is simply not a viable option. You need to be calculated, and you need to protect yourself, while taking risks. There are many approaches and strategies to managing risk, study up, and set yourself up to manage the downside, always.
Price - Is CRITICAL! No matter the asset class or specific investment, the key factor to any successful investment is price. Buy low, sell high, this is they key concept of any investment. You must find the good deal in terms of price, in order to profit from it. So never buy when the price is too high. As Buffet says: “Be fearful when others are greedy, and greedy when other are fearful”.
Compounding - Also known as compound interest, and easy to think of as "interest earned on interest earned". The concept of compounding is absolutely essential to comprehend in order to successfully invest for the future. When you make an investment, you expect to collect it one day along with interest. However, if you can grow your principal amount exponentially by reinvesting the interest earned, you will end up making a lot more money in an exponential curve (non-linear), you'll be making your money back with interest compounded on interest. Make sure you fully implement the concept of compounding into your long term investing strategy. Research this topic further it is critical for you to understand.
Cashflow - (Cashflow, Dividends, and Appreciation) - As mentioned in the Equity Section of the framework, when you invest, you are looking primarily for your investment to be productive (i.e. generate regular returns). Furthermore, as the market value of the investment grows, so does the equity of the investment, which can eventually be sold for a much higher price than purchased (this act by definition is speculation, so don’t simply count on the price to rise when making an investment, unless of course you know what you are doing). When considering your income from an investment, look to maximize your dividends, and if you are confident you should make an educated speculation on the price increasing over time.
Portfolio - If you want to preserve your wealth, don't put all your eggs in one basket! An Investment Portfolio is an organization and categorization of your investments in one place for you to be able to manage, manipulate, and control the variables. As you grow your list of investment holdings, your portfolio will expand, and you will need to re-balance it periodically. You must stay organized when you invest, and your portfolio is the tool/ structure you will use to do so.
Asset Allocation - Asset allocation is a core concept in the world of investing. Think of it as a group of buckets. Each one of your buckets is labeled differently, for example: “Super Safe”, “Conservative”, “High Risk/High Reward”, “Experimental”, etc. To each one of your buckets you will want to assign a % of your investment portfolio depending on your strategy, which should be formulated based on your financial goals (i.e. aggressive, conservative, etc.). Your asset allocation approach should be well calculated and adjusted quarterly for optimal performance. As you accumulate productive assets/investment, you will need to adopt clear guidelines for managing your asset allocation approach, and translating it into a well diversified portfolio of investments across time, location, sector, and business models.
Part 2: Basic Principles
The motto "time is money," is false. The motto should be "money is money" meaning money makes money. The reason being the notion of investment. When investing, you are spending your currency (expense), and purchasing assets, which will hopefully appreciate in value over time (price/equity increase), and generate a dividend (income).
For individuals having difficulties wrapping their head around this overview, it can help to abstract the concept and think of it as follows:
Dividend vs. Price: The best investments on paper are productive investments, ones that pay you back regularly, this payment is otherwise referred to as a dividend. However, the greatest amounts of wealth are built upon the increase in the value/price of the asset you allocate your money towards, with a varying degree of speculation (by definition), think of these equity investments as some of the most calculated risks you take when allocating capital.
Beginners: If you're just getting started we recommend you start with the classic approach to investing: Never, ever lose money, thus, instead of taking-on big risk/reward investment scenarios, start by focusing on protecting your wealth; figure out how to invest your money without losing it, although your gains won't be as large at first, it is the prudent and responsible point to start from, as it eliminates much of the psychological barrier to investing if you're fairly confident you will not lose your money. Moreover, removing the risk of ‘blowup’ (i.e. losing everything, or losing a significant enough amount to cause permanent damage), is not only meant for beginners but for experts at the highest levels as well.
ROI: From here, the next key metric you want to look out for is your ROI (Return On Investment). Say you put in $10K as an investment the difference between a 10% to 20% ROI is significant, and the larger the sums get, so do the payoffs, so always stay focused on your ROI (total and percentage). Generally, when assessing an investment opportunity, start with the most basic items to consider:
Return On Investment (ROI), total and percentage
Total Income Generated (All)
Total Price Change Over Time
And again, never ever ever forget about the risk!
The Goal: Always remember, the ultimate goal for any investor should always be, at the most basic level, to generate enough income from their investments to live on comfortably, retire on, and/or to support their loved ones. The goal of investing is to free up time, by generating enough cashflow, in order not to have to sell time for money.
As you work toward this ultimate goal, you should assess and analyze each investment you make in order to maximize your returns. At FPF, we do not recommend day-trading (i.e. buying and selling daily/regularly), until you are well versed in market mechanics and understanding of market cycles/ structures, so when you are investing do so for the long run, and focus on the future.
Part 3: Investment Options = Assets
There are a seemingly overwhelming abundance of “Investment Options” out there. Just open any financial news-outlet and you’ll be swimming in information on stocks, bonds, commodities, and currencies. However, there is also a different way to look at investment options in a contextual view. Much like income generation which can essentially be reduced to a single act/transaction-type, i.e. a sale, so can investment options be reduced to a single act/transaction-type, a purchase of an asset. In other-words, there is only 1 investment option, the only ‘thing’ to invest in is an asset.
An asset is an object, tool, business, or technology that fluctuates in value over time, and ideally generates income in the form of dividends.
* Quick Note: "Value Investors” will not consider an asset to be one if it does not produce a dividend. A fundamental approach to investing, which determines the value of an asset to be linked directly to its productive ability to generate cashflow for said investor. On the other end of the spectrum are the more speculative investors, traders, and venture/risk-takers. These investors purchase an asset with an assumption it will increase in value/price over time. These are fundamentally different ways of measuring value over time.
2 Types of Assets
Productive: What determines the productivity of an asset is simple. Does it yield a dividend? i.e. does it create cashflow. A rental property, public stock, bond, farmland, small business, even a hotdog stand can all be considered productive if they generate income for their owner.
Unproductive: An unproductive asset is speculative in nature. Since it doesn’t produce income, its value is determined by the market. i.e. what another person is willing to pay for it. The price can/will fluctuate over time. Purchasing an asset with an assumption it will increase in value exposes investors to greater risk. A rental property, public stock, bond, farmland, small business, even a hotdog stand can all be considered un-productive if they do not generate income for their owner. However, they can be sold for a price. In this instance one should always aim to “buy low, sell high”.
4 Asset Classes
All possible investment options fall into one of four options called asset classes. These classes are what make up an investment portfolio, and an asset allocation strategy for that portfolio. More on this topic below. Asset classes are distinct from one another in nature. They are not necessarily correlated, although they are intertwined both on the micro and macro levels. As part of an individual asset allocation, one should aim for exposure in every class. However, the degree of exposure should be carefully calculated based on objectives, time-scale, risk-appetite, degree of determinism/indeterminism, circumstance, etc. A famous saying states the investment context for asset classes, one which applies to various scenarios:
When assessing an investment/ capital-deployment, these are the four asset classes one must choose from:
Or Stocks as most of us refer to them. Symbolize an equity stake, i.e. ownership, of a portion of company’s equity = Assets & Liabilities.
An interchangeable good or material, which can be bought/sold freely as an article of commerce. Commodities include agricultural products, fuels, and metals. They can be traded by individuals as well as in bulk on a commodity exchange or spot market.
Fixed cashflow generated by an investment or loan. Fixed income securities provide periodic income payments at an interest or dividend rate known in advance by the holder. The most common fixed-income securities include Treasury bonds (i.e. loan to govt.), corporate bonds (i.e. loan to corp.), CDs - certificates of deposit (i.e. loan to bank.) and preferred stock (productive asset, ownership in corp).
These are liquid instruments, things you can spend/trade quickly and with ease. Currencies. Short term govt. Bonds. Crypto currencies. These types of assets include bank accounts, marketable securities, commercial paper, Treasury bills and short-term government bonds with a maturity date of three months or less. Marketable securities and money market holdings are considered cash equivalents because they are liquid and not subject to material fluctuations in value.
In the world of investing there are a plethora of investment options for your money to make money depending on your interests, goals, diligence, and creativity; the real problems investors face are how to effectively select the right investments. Where is the right place to invest?
The answer to this elusive question is subject to various external factors, namely: access to information, timing, objective, and strategy. The truth is answering this question depends on specifics. There is no right answer. There is no one size fits all approach to investing effectively. However, if one operates with a clear understanding of financial context, then effective investment becomes determinate and successful over time.
Asset Allocation Strategy
Depending on one’s objectives, risk tolerance, trimming, and capital deployment, one’s asset allocation strategy will vary. Asset Allocation refers to the various amounts of capital one deploys/ invests across the 4 asset classes, and the various subcategories within them, i.e. diversification & concentration. Simply put, Asset Allocation means the various “buckets” you put your money in. One can be super safe, another super risky, depending on your strategy and organization.
FPF EXERCISE: SETTING UP YOUR ASSET ALLOCATION STRATEGY
Consider your asset allocation strategy.
If you’ve sectioned off X amount of capital for investment:
How do you divide it up across asset classes and why?
Are you trying to protect it over time?
Are you trying to grow it quickly?
Consider the market forces at play, where are we in the long-term, short-term credit cycles?
What are interests rates looking like?
Which asset class mix/combination are not-correlated? Which ones are? How can you use this to your advantage in reaching your desired goal?
Set up a number of 'mock-portfolio’ examples on a spreadsheet, compare and contrast them. Simulate various scenarios across short and long term views.
Food for thought:
Legendary David Swensen: Asset Allocation & Diversification.