DIY Investing: Laying the Foundation
Anyone who builds anything knows that you must build it upon a strong foundation for it to withstand the tests of time. This is hardly a new and revolutionary concept. Here is a very short biblical passage that addresses this:
Matthew 7:24-27 New International Version (NIV)
The Wise and Foolish Builders
“Therefore everyone who hears these words of mine and puts them into practice is like a wise man who built his house on the rock. The rain came down, the streams rose, and the winds blew and beat against that house; yet it did not fall, because it had its foundation on the rock. But everyone who hears these words of mine and does not put them into practice is like a foolish man who built his house on sand. The rain came down, the streams rose, and the winds blew and beat against that house, and it fell with a great crash.”
If you are going to manage your own investments and build your own portfolio, this analogy applies completely. You must build upon a solid foundation to make it last the tests of time. We feel that foundation is based on choosing an appropriate path that makes sense for you and then learning as much as you possibly can about that method of investing to avoid costly mistakes.
When we started our own investing with an advisor, we thought of investments as synonymous with stocks, bonds and insurance products. This is probably a pretty common thought process for anyone who has ever worked with a financial advisor. This is what they sell and so it is where they will focus their attention.
As anyone who reads this blog with any regularity knows, I am a big fan of the work Todd Tressider does at Financial Mentor. He outlines 3 paths for building wealth which provide a better way to consider investment options.
1. Private Business
2. Real Estate
3. Paper Assets (Stocks, Bonds, etc.)
Looking at investments in this way, you can begin to see that you have different options with many different features that make them better or worse for your personal situation. Business and real estate both have much higher upsides, better tax advantages and give you much more control over your outcomes. Don’t take my word for it. Click on ABC’s “Shark Tank” this Friday night, watch any sporting event and look at the owners in the luxury box, or find me any other person with great wealth and you are almost assured of finding someone who followed one or both of these paths.
Paper asset returns have a limited upside, minimal tax advantages, and your results are ultimately tied to market forces out of your control. Being successful with this path is highly dependent on having a high savings rate and time to allow your savings to compound. Thus it is much harder and slower to build wealth in this way, and most people are not successful. It is very important that you consider all of these factors and your own personal goals and objectives when considering how you want to focus your investing and wealth building process.
Despite the drawbacks, we have elected to focus on paper assets as our primary mode of investment for several reasons. It is by far the most passive form of building wealth. It requires only a few hours of our time per year. This allows us to focus on earning money through careers which we have already established and enjoy as well as doing other things we would rather be doing. Contrast this with building a business or investing in real estate which is essentially a job itself. Having already built substantial paper assets through saving and being established in our careers when we took control of our investing, it made more sense for us to learn how to first do better in this area than to learn something completely new. We are not looking to build enough wealth to try to buy a professional sports franchise or be a “shark”. Our simple lifestyle, even with an early retirement, can be supported primarily by a portfolio of paper assets.
That said, we do feel that to be truly diversified you should have more than one income stream, and so we are learning about developing alternative streams of income in our early retirement to provide more financial security than our portfolio itself could provide.
Once we established how we wanted to focus our investing, we needed to develop a strategy and plan that made sense for us. Realizing that choosing paper investments meant that we have limited control over our ultimate returns, we decided we needed to educate ourselves on what things we can control so that we can focus on them. Those things in no particular order are:
- Increasing our savings rate,
- Controlling investment costs,
- Controlling tax burden,
- Gaining a full understanding of our investments to avoid making costly errors due to ignorance or emotions,
- Finding an acceptable risk/reward ratio for our investments, and
- Developing a plan to allow us to utilize our investments to support our lifestyle without having to sacrifice the things that bring us value or bring undo stress upon ourselves.
Considering these factors, we came to the conclusion that we would focus on a strategy of passive index investing as it best meets our objectives. We feel that even if you are using a personal business or real estate as your primary modes of investment/wealth building, you will find value in learning about this strategy because at some point you will want to have a place to park and grow your money.
Index investing is a bit counterintuitive. Typically, we think that we get what we pay for. Indexing focuses on minimizing costs and taxes, allowing you to keep more returns because of what you don’t pay for. Typically we think that we can work harder to get better results. Index investing is all about sitting back and allowing your money to work for you. In fact, once you develop a solid plan, doing more than sitting back and following it will most likely worsen your outcomes because the fees and taxes generated by trading more often almost always lead to worse results (not to mention wasting time).
If you, like us, want to better your financial situation but never knew where to start with investing, join us over the next few weeks. We will review a few resources that go from basic to advanced and general to specific that have allowed us to develop a plan to invest with confidence. As we go, please share in the comments any resources that you have found particularly helpful as we are always looking to continue to learn and share.
*Image courtesy of digitalart at FreeDigitalPhotos.net