Once you think about any topic for long enough, you begin to develop a personal philosophy about how it works. This could be your perspective of how to best throw a baseball, how to make the perfect souffle, or how to best tackle a sudoku puzzle.
I happen to think about investing, finance and business an inordinate amount, so I have the beginnings of philosophy in this realm. The great thing about any paradigm is that it is subject to change, refutation and revision: the rules I developed below are intentionally broad-stroked for this exact reason.
What follows are my five general imperatives of investing. They are applicable primarily on a personal finance level; I imagine the technically inclined will be disappointed in the lack of specifics.
First, do no harm.
This certainly seems an obvious piece of advice, but it is remarkable that many people conflate investing with gambling. If you manage to save a certain amount of money, one of your primary goals should be to preserve the principle.
You wouldn’t purchase lottery tickets under the guise of investing: you similarly shouldn’t invest in things you don’t clearly understand because it is what you feel investors should do.
Understand appropriate time frames.
This was a lesson learned the hard way. I’ve always invested in inequities under the assumption that I am young and retirement is far away. Those are both true, but I missed a key point: there are plenty of things to save for in a drastically shorter time frame.
I was, in fact, saving for a down payment for a house through equities, under the assumption that that time frame was far off. When an incredible buying opportunity arose – a collapse in the real estate market – the money I had saved was tied up in the stock market, which has taken an even stronger beating.
There are numerous things worth saving for, each with its appropriate time frame and investment implications: emergency funds, education, retirement, children, etc. Saving in and of itself is fine, but you should always ask, what am I saving for?
Liquidity when needed.
As a corollary to the previous point, understanding the appropriate time frame for investing means recognizing the importance of liquidity when you need it. In the example I gave above, I wasn’t worried about losing money on stocks for retirement – I have plenty of time to make that up.
But I do worry about not being able to substantially participate in this down market in real estate: if I had been saving money for a down payment through more appropriate investments, I could have acted. Investments – stocks, bonds, real estate, commodities, and so on – occasionally go on sale, which we generally call a crash in that particular market.
An intelligent investor has the liquidity to make such investments at just the right moment.
Liquidity can also apply to living just as well as investing. A job loss, sickness or unforeseen emergency demands liquidity in your savings. We are unfortunately witnessing just how fragile this is for most Americans.
Understand your tax situation.
Anyone who has owned a business knows the burden of high tax liability. An intelligent investor knows the same: dividends and capital gains are taxed, usually at both the federal and state level. Yet there exist investment vehicles for every tax situation, from retirement accounts (tax-free/tax-deferred) to municipal bonds. One should know where one stand.
Lastly, understand active investing versus passive investing (at least how I define these terms, which may not be standard).
We’re all familiar with passive investing: stocks, bonds, savings accounts. For the vast majority of us, there is little to nothing we can do to change the underlying value of these investments.
You can’t reprice the bond; ask the bank to give you a higher interest rate or call up the management of the company whose stock you own and plead with them to do a better job. Rather, you just invest and hope for the best. Pay and pray, as it often said.
Active investing – at least as I define it – is investing in something whose underlying value you can affect. If you own stock in a small private company, there are things you can do to increase the value of that stock.
If you own a rental unit, you are actively managing this investment: the decisions you make on how to run the rental business will alter the outcome of the underlying investment, in this case, your down payment. I see active investing as a bridge between entrepreneurship and passive investing.
When you invest in stock exchanges, you are investing in a business. Active investing is also about investing in businesses – it just happens the scale is usually much smaller. Putting up capital for a working farm and sharing the profits, rental properties, and online properties with revenue opportunities are just three examples of these types of investments.
These are powerful and often overlooked investment opportunities.
These five points comprise the foundation of my personal investing worldview. Each, of course, can be broken into specifics, but a broad overview, I think, is interesting and helpful in determining what an investor should be thinking about. The simple process of outlining my perspective was immensely instructive and something I certainly recommend.