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Winning Investor's Guide to Makingby Andrew Horowitz
Step One: How Much Time and Energy Do You Want to Spend Managing Your Money?
The first thing you need to know about investing is that there are different ways to invest. When they hear the word investing, many people think of stocks only, not realizing that many other investment vehicles exist. Ill explain all of the basic options in chapter 2. Because there are so many options, the first decision you need to make is: how much time do you want to spend researching potential investments, choosing and deciding what to invest in, and managing your investments? Investing can be a full-time activity, or it can be something you do only part time. Only you can decide how many hours a day, a week, a month, or a year you will spend on your investments.
You may also decide to work with somebody else to come up with a game plan that meets your goals, and if thats the course you want to take, you can learn more about that in chapter 11, which will give you quick and dirty tips on choosing a reputable and qualified financial advisor. Its up to you to decide what kind of investor you are (or want to be), what exactly you want to do, and how much you want to be involved in managing and tracking your investments.
What Are Your Investment Goals?
Asking yourself why you want to invest may seem obvious, and if youre already clear on what your financial goals are in the short and long term, then feel free to skip this section. But if you havent really thought about what you want to do with your money and when you will want to spend it, then you need to start thinking now. Time is critical when youre investing. If you need money tomorrow or within the next six months, you should probably be “investing” your money in cash, via a savings account, money market fund, certificate of deposit (CD), or short-term bond. On the other hand, if youre saving for retirement, then you have a much longer time frame—depending of course on how old you are and how close you are to retiring.
When you hear or use the word invest, dont confuse it with investing in company stocks only, which, as mentioned earlier, is what many people do. They think of investing only in terms of the stock market—that is, buying individual stocks, like Microsoft (MSFT), Pfizer (PFE), and so on. But investing encompasses so much more than just the stock market: you can invest in bonds, cash, mutual funds, ETFs (exchange-traded funds), and more—all of which Ill discuss in chapter 2.
We need to think of the word investing more along the lines of saving, preparing, and planning. In short, when you invest, youre simply putting money into something that you believe will pay off in the future. The first thing to determine—before you put any money anywhere—is how far into the future youre going to want to access that payoff, and what youre going to use it for.
Lets consider a few typical possibilities:
Are you investing for your retirement?
If so, when do you want to retire?
How much money do you want to have (or do you think youll need to have)?*
*This is a tough question, even though there are myriad quick and dirty worksheets to help you calculate your retirement needs. If youre interested in mulling this problem further, take a look at The Number: What Do You Need for the Rest of Your Life and What Will It Cost? by Lee Eisenberg. Although this isnt a practical book (in that it doesnt tell you how to invest to attain that “number”), it is an intriguing book about one mans quest to figure out how much he and his family really need, and how much you might need as well, depending on what standard of living youre seeking in retirement.
Are you investing for your kids college tuition? How far off is college? Are you the parent of a newborn, with seventeen years to accrue the money youll need (though who knows what college will cost in seventeen years)? Or do you have thirteen-year-old triplets who want to go to Harvard, Yale, and Brown in five years?
Are you investing so you can buy a house?
If so, when do you want to buy? Again, your answer will affect whether your investments will be long-term (e.g., if youre twenty-one years old and want to buy a house by the time youre thirty) or short-term (e.g., if you want to buy a house within the next year).
How much will you need for the down payment?
I realize these life goals require lots of self-knowledge and long-term planning—and you may have no idea yet what you want out of life, especially if youre relatively young. When the goals youre saving for, like buying a new house or retiring, are so far off, it can be hard to even think about investing, let alone actually do it.
One of my clients told me that when she was twenty-five, she didnt fully participate in her companys 401(k) plan because age sixty-five seemed like a lifetime away (and it was!). Plus she earned so little money that the thought of setting any of it aside was painful, and so she invested only the 2 percent of her salary that her company automatically set aside for her. After five years, her boss mentioned he had amassed $63,000 by investing the maximum allowable amount of 6 percent, with a matching contribution of another 6 percent from the company. During this time my client had accrued only $7,000. When she heard that her boss had accumulated enough for a healthy down payment on a house, she hightailed it down to Human Resources and increased the amount she invested. Fortunately, she was still young enough to save and invest wisely, and so twenty years later, shes very comfortable. Thats an example of the power of the compound effect of interest—but you need to start young. Figuring out your goals is a good way to start.
Quick and Dirty TipHow to Figure Out Your Investing Goals
Try to identify some financial goals, because when you want the money and what you want it for will direct how you invest. Write the goals down so you can refer to them later.
One of the most important goals you should have is to save enough to have the kind of retirement you want. Almost every investing Web site and periodical includes a tool or worksheet to help you calculate how much money youll need to save. Most ask you a few questions to give you a ballpark estimate, such as:
your annual salary
how much youve saved for retirement in your 401(k), other savings, or both
how much you save each month
whether your investing style is aggressive, moderate, or conservative
Fidelity.com has a helpful interactive worksheet. You can get to it by clicking on “Guidance & Retirement,” then on “Retirement,” and then on “MyPlan Snapshot.” Assuming you plan to retire at age sixty-five, the tool gives you two different amounts that it estimates youll need for retirement:
one amount based on the market performing poorly
one amount based on the market performing on average
As mentioned, many other similar worksheets are available. A simple Google search for “retirement calculator” should help you find them.
Lets take a look at what a simple retirement calculator looks like.
As you can see, the calculator asks you to input only a few variables:
Annual income required: How much money do you think youll need to live on each year, once youre retired?
Number of years until you retire: This depends on your age. If youre thirty and plan to retire at sixty-five, then you have thirty-five years until retirement; if youre fifty-five and plan to work until youre at least seventy, then you have fifteen years; and so forth.
Number of years required after retirement: This is, of course, a difficult question to answer because who knows? Give it your best conservative guess.
What you think the annual inflation rate will be: This is another tricky number to estimate. In the 1970s, the inflation rate was above 7 percent, but during the first decade of the twenty-first century, it was below 3 percent. We cant know for certain what the rate will be, but for now lets use 4 percent.
Annual yield: What interest rate do you expect (or hope) to receive on the money youve saved or invested?
Now, lets look at a popular retirement calculator from MSN Money at http://moneycentral.msn.com/retire/planner.aspx, where you can find and input your own variables.
It asks us a few more questions than the basics we just covered, such as how much money we have saved already, what our current salary is, and how much we are contributing to our retirement as a percentage of our salary. The MSN Money calculator assumes a 3 percent annual inflation rate, which is preset and you cannot change in the calculator.
Heres a sample calculator for Olivia, a single forty-five-year-old woman who already has $50,000 saved for retirement, plans to retire at age sixty-five, and guesses that shell live until age eighty-five.
After inputting the information, the calculator shows Olivia that after retiring, shell be withdrawing over $25,000 each year from her savings and investments, which will be added to her other retirement benefits to receive $40,000 annually.
It also says that, assuming a 7.0 percent annual rate of return and that her 10 percent annual contributions continue, Olivias retirement savings would grow to almost $295,000 when she turns sixty-five.
That number might initially sound great, but as you can see, the calculator also tells Olivia that her retirement savings would run out when she is seventy-nine years old—six years before she predicts shell stop needing it. That tells her shell need to adjust her savings or expected spending in retirement.
Lets say that she starts saving 15 percent of her income each year instead of the 10 percent that she does now. With that change, the calculator tells her that her retirement account is expected to grow to $386,000 when she retires at sixty-five. The calculator also now shows that she will run out of retirement savings at age eighty-five, which is what she input as her life expectancy. If she feels like she might live longer than that, she might try saving 16 percent or up to 20 percent of her annual salary.
Keep in mind that your salary will hopefully increase over the years. Though this sample calculator doesnt, some calculators allow you to input your expected percentage of salary increases each year, which may be 1 percent to 5 percent per year depending on your career.
Spend some time using different calculators and inputting different parameters. If you have a spouse, be sure to add his or her information into the calculations if you combine your retirement accounts. Some online calculators allow you to calculate individual information for your spouse as well.
This information can be very eye-opening, especially if you find out that you will not meet your retirement goals if you continue saving and investing as you do right now. Though learning this might be painful at first, it can help put you on the right path for a secure future.
Investing Helps You Achieve a Secure Future
Most of us want to have a secure future, and so we need to identify our goals now—particularly how much money well need for retirement—before we actually need that money and learn that we dont have enough. In addition to saving for retirement, you may have additional goals, such as saving to buy a house or paying for your childs education. Its not enough to simply wish for the best and hope that money will be there when you need it. Identifying your goals will enable you to put together the plan you need to reach them. And learning how to become a winning investor will help you achieve them.
Why Investing Today Is More Important Than Ever
The world has changed dramatically over the past few decades so that in terms of taking care of and planning for your own financial security, you really need to make your own way. Most companies used to provide retirement plans for their employees. Called defined benefit plans, they stated unequivocally (thats the defined part) what the company would pay you (thats the benefit part) when you retire. The plan would say something like “When you retire, youll receive $2,000 a month from us for the rest of your life.” (Of course, the final amount depended on annual salary and how many years the employee worked for the company.) Plus, there was Social Security income from Uncle Sam (more about that in a minute).
Around the mid-1980s, many companies changed their approach to employee retirement plans: they no longer offered the defined benefit plan. Instead, they started offering defined contribution plans, most often 401(k) plans—which required you to contribute to your own plan. In other words, you were now in charge of saving and investing for your own retirement, and the most your company would do was match a portion of your contributions.
All of a sudden, youre on your own: you are solely responsible for deciding how much of your paycheck youre going to save for retirement, and how you want to invest that money. So youd better know what youre doing!
Even worse though, not only are you on your own, but in the wake of the financial meltdown of 2008, there arent any guarantees that your employer will continue to make matching contributions; many companies have eliminated this benefit in order to save money. Now youre totally responsible for your future financial well-being.
In other words, over the last twenty years, retirement planning has changed completely. Whereas employees used to have a secure and planned retirement as part of an overall benefits package, now you can work for twenty or thirty years, getting your regular paycheck, but if you dont contribute financially to your retirement plan, youre not going to get anything on the way out.
In short, you need to figure out your financial future now, because more than ever before you are responsible for your own personal finances, your own personal stability, and your future. You need to plan as if nobody is going to be there to support you.
To add more salt to your financial wounds, we cant even say whether Social Security will be available when we retire. If youre a young person—or even if youre in your forties or fifties—you cant count on receiving it. For most of us (unless youre close to age sixty-five), Social Security is just a vanishing mirage. Of course, we continue to receive annual updates from Uncle Sam, indicating how much we should receive when we retire, but we certainly cant depend on that money, because it is possible that the system will eventually be bankrupt.
Here it is, in a nutshell: you have to be that much smarter about how youre investing because youre bearing all the risk and responsibility for your investments. Thus it is very important to know what youre doing. You can no longer just make assumptions and believe that the future is going to be a certain way. The world has changed too much. That doesnt necessarily mean that its worse, but it has changed, and so you need to be more adept in understanding investments and how they work.
How Much Time Do You Want to Spend on Your Investments?
Essentially, there are two types of investors: passive and active. However, there are degrees of each, and I tend to think of them on a continuum, as shown in the accompanying diagram. Lets look at each investor type in terms of how much time and energy each is putting into investing.
What Type of Investor Are You?
Superpassive Passive Fairly Active Active Superactive
If you plan to check on your investments and to consider changing your portfolio, or collection of investments, once or twice a year, then youre a superpassive investor. There are tens of millions of people just like you. Superpassive investors are often people who invest for the long term primarily through their 401(k), 403(b), IRA, or other retirement account; in other words, they dont have any other type of investment, such as an individual brokerage account. This group really doesnt want to research specific stocks, bonds, or alternative investment opportunities, so they simply invest in mutual funds or exchange traded funds (which Ill talk more about in chapter 2).
Heres an example of a superpassive investor: Cami is forty-five years old, and she has a good job, where she works a regular eight-hour day. She has a decent 401(k) plan that shes been contributing to since she graduated from college and got her first job. Shes also married, with four children. She and her husband Fred have decided they dont want to spend a lot of time reading financial newspapers and magazines or watching financial news commentators on TV who are espousing their view of the markets. But Cami and Fred do want to invest for their kids college educations and for their eventual retirement.
Therefore Cami and Fred have decided to invest in mutual funds and ETFs (well discuss these in chapter 2, or you can turn to the glossary for quick and dirty definitions). Cami and Fred are traditional “buy-and-hold” investors; in other words, they plan to hold on to whatever they buy for a long time. Theyre not going to track the price of what theyve bought today so that they can sell at a profit tomorrow, or next month, or even next year. Theyre trusting that theyll earn money over the long haul.
The Buy-and-Hold Investing Strategy
Buy-and-hold is a popular strategy for many investors, including the famed Warren Buffett. Buffett, whose approximate net worth is $47 billion, made his money solely by investing. Although hes hardly a passive investor, his long-term investing strategy fits that of a passive investor. There have been dozens of books written about him and his investing strategy, based on his preferred investing time frame, which he says is “forever.” His attitude is, “Ive invested in a quality company, so why should I get rid of that investment?”
Buffetts strategy can certainly work if you have a long enough time frame. All things considered, a broad-based and well-researched diversified investment portfolio can do well over many years, so you dont have to watch over your investments every minute. In fact, the buy-and-hold strategy has also been called the “Sleeping Beauty” portfolio, because you essentially go to sleep for many years, hoping that youve chosen your investments wisely, and then you wake up and see if your investments have paid off as you planned and hoped.
Keep in mind that Buffett is really in a class by himself as an investor, because he doesnt simply invest in companies the way the average investor does. Instead, he frequently buys entire companies so that he has direct control over how they are run, so in those companies, he is more of an owner-investor.
The problem with the Sleeping Beauty strategy is it doesnt work if you dont have a long enough time frame. Suppose Cami, our superpassive investor, followed her buy-and-hold approach. She was forty-five when she started and is sixty-six today, retired, and drawing income from her hard-earned retirement money. Lets say she retired in early 2010. In that case, Cami, as Sleeping Beauty, would have awakened in 2010 ready to use her investment money for retirement … but, unfortunately, she lost out because she happened to be born on the wrong date. In other words, because Cami retired at a time when the market wasnt doing so well, her investments—when she needed to start using them—were worth much less than she thought they would be. It wasnt her fault, of course, because she did all the things she was told to do.
Now how do you get around that? Thats the $64 billion question: what can Cami do now? There are many people just like our fictional Cami who are facing this very same concern.
In the aftermath of the stock-market meltdown of 2008 and others throughout the last century, its my opinion that the buy-and-hold strategy needs to be requestioned. I firmly believe its no longer a good idea to simply put your money into some investment, let it sit there for decades, and accept that whatever happens, happens. Thats a lazy portfolio, if you will—and it can have a very detrimental effect on your financial security and well-being. If you choose to be a superpassive investor, just be aware of the risks involved.
If youre spending, or planning to spend, about five hours a month on investing, youre still a passive investor. Five hours a month isnt enough time to keep on top of everything you need to be researching, watching, thinking about, and deciding on. Its not enough time for you to be considered an active investor. Again though, there are millions of people like you, and you just need to know how to make the best use of the time you do spend on investing.
Heres another example: Adam, who is fifty-two years old, runs his own business, which means he has a demanding workload consuming long hours. Hes also married to Judy and has a couple of kids, and he wants to spend most of his spare time with his family. Hes willing to spend an hour or so every weekend keeping up on what he needs to know to ensure his familys financial security.
That “hour or so” once a week, however, adds up to only about five hours a month, which isnt enough time for Adam to actively manage his investments—or for you to manage yours. Although Adam wants to have a cursory understanding of the financial markets, his investments, and the risks hes taking, he also decides to hire a professional financial manager or advisor (which Ill discuss in chapter 11). Because working with a financial advisor means Adam will be checking in with and meeting with this advisor—which of course takes time—Adam isnt a superpassive investor like Cami; hes a passive investor.
To sum up, passive investors may spend about five hours a month on their investments by handing them off to somebody else or by having a fairly lazy portfolio. Then they can focus on their main business or job, where theyll make most of their money. If youre a passive investor, then you probably have something to do in life that you consider more important than actively managing your investments. All you really want to do is check your statements every so often, read the financial news on a daily basis, listen to an occasional financial news program on radio, TV, or a podcast, and talk to your advisor perhaps a few times a quarter. It will be your advisor who will be doing the heavy lifting of researching possible investments for you and monitoring your existing investments to make sure they help you reach your financial goals.
Fairly Active Investors
Unlike passive investors, fairly active investors really want to get involved in investing. They are willing to spend a half hour or so a day to monitor their investments, looking at ideas for new investments they might want to research, and checking up on how their current investments are doing.
For this example, Danielle, in her thirties (although age is not a determining factor), simply has more energy and time than our earlier investors, Cami and Adam. Shes single, with no children, and although she works long hours at a demanding job, she still has time to research and monitor her investments. Danielle either devotes 30 minutes a day, 7 days a week, to this or else spends 3½ hours doing so on the weekend.
Either way, thats certainly enough time for her to scan Barrons or look at the recommendations of Investors Business Daily, which has a great list of highly rated stocks and mutual funds that she might want to research further. She might also read other financial newspapers and magazines to get ideas for possible investments, review her portfolio, and sketch out an idea a week for an investment she wants to review further. (Well cover analysis and research in Part II.) Unlike Adam, Danielle doesnt want to leave the decision of what investments are in her portfolio to her money manager, and unlike Cami, she doesnt want to just hope her investment choices do well in the long run. She therefore sets aside at least 3½ hours a week to discover new investing opportunities that she believes may help to increase the value of her portfolio.
If 3½ hours a week isnt enough time for you to monitor and manage your investments, then you might want to be an active investor: someone who spends about three hours a day reading, researching, and investing.
For example, Karen, who is forty years old and works an eight-hour day, has free time in the morning before work and in the evening, which she chooses to not spend watching TV, socializing, or indulging in any other leisure activities. Instead, Karen is willing to devote 3 to 4 hours a day on her investments. She probably spends 1½ hours in the morning looking at what her investments are doing, monitoring the markets, and reading the financial news. She looks to see if theres anything she might want to buy or sell. Then at the end of the day, shell review what happened, where the markets closed, and what additional news came out. She can then follow up on daily trends.
Karen reads several investment newspapers and magazines, watches financial news shows, and listens to investment podcasts, just to get ideas for what to research further and consider investing in. She also spends time analyzing those potential investments by doing either fundamental or technical analysis (which well cover in Part II) to determine whether the preliminary investing ideas shes gotten from her research are really worth sinking her hard-earned money into. Of course, she needs to monitor the investments she decides to make, which may lead her to buying and selling more often. That is why shes an active investor. Karen wants to make sure shes not missing out on any great investment opportunities or holding on to something, like a falling stock, when she should be getting rid of it.
Active investors are people who want to be involved, have more of an interest in money management, and maybe even want to supplement their incomes with trading or investing. These people have a much greater intellectual commitment to investing, and generally they are willing to devote a great amount of time to it. That may be the amount of time you want to devote to your investments too.
If you think three hours a day still isnt enough time for you to read, watch, research, and monitor, you may want to be a superactive investor. One such investor—Ill call him Mike—is likely not working at another job, at least not full-time, but he is willing to devote himself full-time to his investments, spending about eight hours a day, five days a week. In other words, the superactive investor is going to be thinking about his investments all day. Mike might be a professional money manager like me, whos managing money not only for himself but also for other people, his clients.
However, Mike is not a day trader. There is a difference between superactive investing and day trading. Investing is the art of buying stock, bonds, real estate, or any other type of investment because you believe its going to do well over time, even though there may be hiccups here and there. Over time, you believe that a stock, for example, is going to do well, and so you want to be invested in that, you want to hold on to it. I dont call this buy-and-hold necessarily; instead, what youre doing when youre investing is taking a position that youre willing to hold on to over time because your research shows that this will be a good longer-term opportunity for yourself.
How Active Do You Want to Be?
Now that you know the amount of time involved in each approach to investing, take a look at the spectrum again, and decide where you want to be.
What Type of Investor Are You?How Much Time Do You Spend on Investing?1. SuperpassiveYou review investments once or twice a year.2. PassiveYou review investments about five hours per month, but you also work with a financial advisor.3. Fairly activeYou read, review, and research thirty minutes a day or three-and-a-half hours a week.4. ActiveYou read, review, and research three hours a day.5. SuperactiveYou read, review, and research eight hours a day, five days a week, focusing on medium- to long-term investments.Do you want to buy and hold for the long, long term? Or do you want to be in and out of the market, attempting to time it so that youre buying and selling and trying to make money all the time? Some people want to invest because they believe its easy—they think, “Look, the market goes up and down; I can make money and its a quick buck.” Their attitude often changes very quickly though when they have to put their own money on the line and decide, “Do I stay in? Is the market going down more? Should I put more money into this investment? Is the market going up? Do I want to change something?”
Thats why the first big questions you need to answer are: Do you want to manage your own money? How much involvement do you want to have? Do you want somebody else to manage your money? Do you want to be checking on your positions on a daily basis? Do you want your portfolio to include individual stocks, mutual funds, or ETFS? How much money do you want to risk? How much money and time do you want to spend on research?
Answering these questions will lead you to conclude how youre going to handle investing. Lets say that you want to be involved, at least involved enough to be knowledgeable about your investments and to understand whats going on. Maybe you dont want to know the finer details, but you do want to understand things like “Why am I invested in this market sector (such as technology or health care or manufacturing)? Why is this happening to my investments? What should I be doing?” There are newsletters that you can subscribe to, which provide good tips and give you good research and rankings on investments. There are hedge funds. There are investment advisors. There are mutual funds. (Ill explain these terms in the next chapter.) Theres a whole host of investing choices you can make.
Basically, I believe your decision depends on this: what is the most important thing in your life? Is it important to be with your family? to do well in your job? Is it important to be involved in your community? With your answers in mind, you can decide whether you have time to devote to your investments. Again, it boils down to how much time you want to spend and what you find fun in life.
I do think its important, no matter what your circumstances, that you spend at least some time, have at least some information, and have at least some relationship with your investments. Its not a good idea to just ignore them.
If, after reading this chapter, youve decided you just want to check in once a quarter, once every six months, or once a year, I recommend you proceed with caution. Many people believe the markets, over time, will be higher, but youre taking on a great deal of risk by checking your investments infrequently.
If you want to spend less than five hours a month on investing and if you simply want to understand the basics of investing, then youre a passive investor. I believe you should consider hiring a professional money manager or financial advisor whom you can rely on and trust. I also strongly believe that your money means more to you than to anybody else in the world, so you need to take some responsibility for it, even with a money manager. Ill talk more about money managers in chapter 11.
On the other hand, if youre the type of person who likes to get into detail and reading/researching/monitoring is something you want to do, I think you should choose to be a fairly active investor. Read as much as you can and understand that some “information” is just PR and thus not objective. Its a good idea to keep your finger on the pulse of blogs, podcasts, radio, TV, newspapers, and so on. If you want to be an active or superactive investor and do a lot of analysis, you should consider investing in individual stocks (described in more detail in chapter 2). Keep in mind that you dont want to bite off more than you can chew, because were talking about real money; investing is not a game that uses Monopoly money. Also, you dont want to set yourself up for failure. Dont start investing and then ignore your investments, and dont hand off your money to someone else and not pay attention to how that person is investing it. Again, its your money, and you dont want to lose it.
Copyright © 2010 by Andrew Horowitz
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