Investing to Build Wealth

Four big takeaways 1) You can’t afford not to invest. 2) Diversify and consider investing passively. 3) Be appropriately wary of anyone or anything that charges a fee as a % of

assets- think of fees like a cash expense and adjust accordingly. 4) Robo-advisors are a great option for accomplishing 1-3.

What is investing? Classic economics- spending money in the hopes of making more money. Consider a solar panel The entire economy is based on billions of investment decisions, big and small, explicit and implicit. Should you install a solar panel on your roof?

Figure out costs/benefits Quantify the opportunity cost Act

Cost/benefit analysis requires thinking about how much future cash is worth, compared to present cash If you could invest $100 to get cash in the mail every year, for sure, how much would each payment have to be?

What is speculating? It is worth understanding the distinction between assets that are expected to generate cash flows

over time, and those that won’t. Currencies, crypto or otherwise, art, gold, rare coins, etc. are not investments in that they can only

provide returns if the psychology of others changes favorably. They aren’t designed, structurally, to create returns.

Bitcoin isn’t an investment, it is a bet. Could be a good bet, or a bad bet, but it is bet nonetheless.

How do professional investors fit in?

Borrowers/Sellers

Save

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The Entire Financial System

Financial advisor

Mutual Fund

Investment Bank

Risk, return and asset classes

The more risk/uncertainty in a potential investment, the higher the return it needs to offer investors Think of an investment as having two parts: 1) The underlying 2) The capital structure

The underlying is the business or cash-generating entity itself. It has an intrinsic value. The capital structure dictates how investors participate in gains or losses.

How to choose investments?

Asset allocation is the most important thing

Beyond that, two broad approaches

Passive- buy a cross-section of what’s out there in a given asset class Active- try to pick and choose the winners

I want to underline this: The vast majority of investing profits do not accrue because of the genius of whoever is making investment decisions. These assets are designed to provide returns. Professionals are fighting to try to do better than the average, by picking companies and investments that outperform. Tactics can range from building opinions on the underlying business to complex algorithms.

Diversification

Because the risk of each individual asset isn’t correlated, the more you have, the lower your risk.

This is why instead of buying individual companies, most investors are better off buying funds.

Funds are baskets of assets put together by a provider. You buy one thing, and on your behalf the fund invests your money across various assets.

Consider the most common example: mutual funds (I used to work at one!). Mutual funds invest in public companies. For example, a “growth fund” might invest in shares of high-growth companies

that are expanding and increasing their revenues. As an investor, you buy shares of “XYZ growth fund” and end up owning stakes in

dozens or even hundreds of companies selected by the fund’s manager. Alternatively, in passive form (called index funds), the manager buys hundreds of

companies proportional to their size without trying to pick favorites. This allows for lower fees because you don’t have to pay people to do research. You

Let’s get practical I’ll give one line of savings advice: make it automatic, use mental

accounting (i.e. have an “untouchable” account) and all else equal consider investing your time in trying to earn more money. Now, once you’ve saved, how should you invest? You must invest, you can’t afford not to. I recommend investing passively. I recommend being laser focused on fees. I recommend employing a robo-advisor like Betterment.

You can’t afford to not invest

“Compound interest is the most powerful force in the universe”- Albert Einstein (supposedly, but it is true anyway)

Why passive? Simply put, picking individual companies and assets is hard work, and evidence

shows that even professionals aren’t good enough at it (on average) to justify their fees. There are whole communities of professionals devoted to finding professionals who

can successfully “beat the market,” and even these people have mixed track records. As an individual investor, it isn’t a game worth playing OR paying someone to play for

you. Remember, the more someone charges, the more they can afford to advertise to

you. You are better off focusing obsessively on fees…

Why care about fees?

Why care about fees? (2) One way to help this sink in is to think of fees as a real, cash expense you incur. As you accumulate assets, asset management fees could easily become one of your largest

expenditures, but feel invisible because you never get a bill in the mail. Many “wealth management” firms will provide tons of ancillary services- tax prep, accounting

help, etc. in exchange for collecting a big % fee on your total assets. It feels nice and free, but over time you’re much better off paying hourly.

Why a robo advisor? I am NOT saying that all human advisors are worthless. On the contrary, they can have important roles to play- encouraging you to save,

helping you plan for needs, etc. But for a great many people, especially young savers, a robo-advisor is a great

choice, with some of the advantages of human advisors but super-low fees. They combine a “set it and forget it” quality with lots of modern financial best-

practices to esoteric to cover here, and they have great user interfaces. Betterment, Wealthfront and others are all good choices.

Addendum on market timing

Final thoughts 1) You can’t afford not to invest. 2) Diversify and consider investing passively. 3) Be appropriately wary of anyone or anything that charges a fee as a % of

assets- think of fees like a cash expense and adjust accordingly. 4) Robo-advisors are a great option for accomplishing 1-3.

* John Oliver’s special on “Retirement Plans” is excellent.

Questions?