Ah, that perennial question: “What to invest in? How can I turn my money into still more money?”
Kevin O’Leary, who you might recognize from the show Shark Tank, likes to think of his cash as soldiers or mercenaries. Each dollar has one job: to go forth and capture him even more money.
When it comes to investing, this is the goal. You want to deploy your capital and put it to work. How many people are out there moaning that you “need money to make money?” Well, if you’re wondering what to invest in, you have money, you just need to figure out how to use it capture even more money.
That’s where I come in.
There is a whole universe of possible investments out there. Or so it seems. After you start sorting different possible assets into categories, you soon notice that it’s emphatically not a universe. It’s smaller than that. Much smaller.
It’s not a universe. It’s more like a bucket of rocks. Different-looking rocks to be sure, but a lot smaller than a universe.
Possible investments – that is, asset classes – are like a bucket of about 8 rocks.
Here’s what those rocks are, and my thoughts on them.
- Stocks: This is the granddaddy of them all, the first thing that people think about when they hear the word investments. A stock is a part ownership share of a business. It derives its value from the success of that business. Historically, stocks have performed better than any other class of investment, but this isn’t a free lunch. In bear, depressed markets, those with all of their money in stocks have seen losses of as much as 50%.
- Bonds: You can buy debt. When you do so, it goes by many names. All of those names go under the umbrella of bonds. When you invest in bonds, you’re buying someone’s debt, with the expectation that they’ll pay it back over time, along with interest. The global bond market is much larger than the global stock market but, historically, has had lower returns, along with much lower risk. Except for savings accounts, government bonds are perhaps the safest investment available.
- Money Markets and Savings Accounts: Presumably, you know what a savings account is. You put your money into it and are paid some interest on top of that. As of this writing, yields are low, hovering somewhere below 1%. Money market accounts are implemented differently but, for you as an individual, essentially the same. You put your money into and use it like a savings account. Both of these are nearly risk free with commensurately small returns.
- Real Estate: You have a bunch of different options when it comes to investing in real estate. You could buy a house or a rental property. You could invest in several rental properties by pooling your money with others. Or you could buy a REIT, which is like an index fund, but for real estate. REITs have, in the past, had a risk-return portfolio similar to stocks. You can do better by managing the properties by yourself but, naturally, that’s more work.
In contrast to the investments above, I don’t recommend the following. They don’t, in general, have any advantage over the ones I’ve listed above. Hedge funds are much hyped, for instance, but have high fees, low returns, and are highly correlated with stocks–so why not just by stocks for cheaper?
- Hedge Funds
- Collectibles and Art
- Private Equity and Venture Capital
If you want to know more about possible asset classes, check out Rick Ferri’s All About Asset Allocation.
Two Ways To Do It
Okay, so I’ve covered the possibilities that you have when it comes to the question, “What to invest in?” But I haven’t told you how to do it.
There are different ways to do this. This is my way. Other people have other ways.
There are two classes of investors:
- Lazy investors: These are the kind of people who have better things to do than spend time researching individual securities to invest in. Maybe it’d be better to call them busy investors, rather than lazy investors, but these kind of people want a hands-off portfolio that is a simple to maintain as possible.
- Enterprising investors: These people are the kind that enjoy doing research. If you’re willing to put in the time, do your due diligence, all in pursuit of beating the market-an outcome that is far from guaranteed, you’re an enterprising investor.
The Lazy Investor’s Portfolio
For the lazy or busy investor, I recommend either:
- Investing in one of Vanguard’s target date funds. Pick when you want to retire and invest in that fund. The guys at Vanguard will handle the rest. The only overhead is a reasonable .18% fee.
- Using Betterment. Betterment is an automated wealth management service, which handles your portfolio mostly for you. It’s like having a financial advisor that is smart, ethical, and a robot. Oh, and cheap–annual fees in the highest bracket are .35%.
The Enterprising Investor’s Portfolio
It is, naturally, much harder to be an enterprising investor than a lazy investor. However, even if you don’t manage to beat the market or achieve Warren Buffet levels of success, you will be forced to learn. A lot.
The task of the enterprising investor is deceptively simple: buy cheap securities. Get in on growth stocks before anyone else realizes their growth potential. Buy the next Walmart before it becomes Walmart.
This “buy low, sell high” strategy is straightforward to describe, but much more difficult in practice. After all, if everyone knew some stock was going to be high in the future, it will already be high. That growth will be priced in. Compare the market capitalization of Netflix, for instance, to its earnings. Not cheap.
Anyways, here is the basic workflow for the enterprising investor:
- Do research. This could be talking to people, learning about an industry (maybe by reading a book, like this one on the oil industry, or some other primer), reading through 10k reports, whatever.
- Once you’ve found the major players, estimate how much you think each one is worth. To do this, you’ll have to master the art of business valuation. Try this book or this one.
- Now, compare your estimates to what the stocks actually trade at. Are any of them trading for, say, 50% of what you think they’re worth? Are you confident in that estimate? If so, continue with step 4.
- Create an account with a broker – I recommend this one because it has the lowest fees – and buy shares of that company.
That’s the process, basically. The enterprising investor’s portfolio is an individual creation. I can point the way, but I can’t make it for you. You have to do it yourself.