If you’ve ever held money in a savings account, you’re already familiar with the feeling of ‘having your money working for you’. Investing is no different (barring some additional financial jargon), working on the same basic principle: ‘put something away now to enjoy more of it later’. While some professional investors, like former MergerTech CEO Nitin Khanna, play active roles in managing multi-million dollar investments–not all forms of investing are the same.
So, if you have some savings stashed away beneath the bed and you’re ready to start putting it to work, this article will walk you through what you need to know to get started–along with outlining 4 essential tips for beginner investors.
● What is Investing?
● Types of Investments;
● Active and Passive Investors;
● How and Where to Begin Investing; and
● 4 Tips for Beginner Investors (with Nitin Khanna)
What is Investing?
Most of us use the term ‘investing’ in a variety of contexts: we invest our time into education, and our support or attention into families and communities. The common theme across all investments is the allocation of resources to an asset (or endeavor) with the expectation that this will bring about some future benefit. When it comes to financial investments, this benefit is an income or profit–for other investments it may be a healthy relationship or an educational degree.
So, what is really happening when you invest in a stock, index fund or bond? How exactly is the money ‘being put to work’?
How your money is being used will depend on the type of investment you’re making. We’ll dive into the details of some common investment types below, but simply put: when you invest, you are making some of your capital (in this case, cash) available to a company, government or organization so that they can put it to work on creating new value in the marketplace. When you keep that $1500 tucked away under the bed, you face very little risk of losing it: however, there’s also no way for that capital to grow. Investing is perhaps the primary vehicle of a successful capitalist society, as it allows for funds which would otherwise be idle (stored in a safe, or tucked under the bed) to be put to work in businesses which can then create more value.
Figure 1: S&P 500 Index: Adjusted for inflation)
It’s worth noting that while long-term investments on index funds have steadily tracked upwards over the past several decades: there are no guarantees. Some investments are riskier than others, and the expected returns on an individual stock tend to rise with risk (i.e. the riskier the investment, the higher the potential payout).
Active, Passive and Risk Averse Investors
Before diving into the investment options on offer, the first thing a broker is likely to ask is: ‘What type of investor are you?’ There are two things they really want to narrow in on: 1) ‘How active do you want to be in managing your investments?’ and 2) ‘How much risk are you willing to take on?’
Being a beginner doesn’t disqualify you from wanting to do your own fundamental and technical asset analyses–but odds are, if financial ratios, market research and scraping quarterly reports isn’t your idea of a pleasant investing experience, then there’s nothing wrong with choosing to be a more passive investor.
● Passive investors are inclined to trust the advice of a broker, invest in a more diverse portfolio (or index fund), or invest their money with a passively managed mutual fund.
● Active investors are looking to ‘beat the market’, so to speak. They take responsibility for researching companies and stocks they’d like to invest in, and look for arbitrage and short-term opportunities to make a profit on fluctuations in the market. It’s worth noting that a seasoned investor like Nitin Khanna can take on the role of both active and passive investor–making active investments in promising startups, while mitigating risk with longer-term, low risk investments in the portfolio.
The second question will define the level of risk you’re looking to take on as an investor. Are you willing to risk large losses for a big payoff? Or are you investing for retirement–looking to slowly, but consistently, make a return that’s (hopefully) higher than a standard savings account?
● Highly risk averse investors (low-risk investors) will be more attracted to highly diversified portfolios, index funds and bond options;
● Low risk averse investors (high-risk) are willing to take on more risk with the hope of receiving a higher return.
Types of Investments
Stocks, bonds, mutual funds, index funds, ETFs and target-date funds–the variety of investment options on offer can be overwhelming. Armed with your answers to the ‘risk averse’ and ‘active-passive’ questions above, though, you should now be able to narrow in investment opportunities which match your needs.
Here’s a quick overview of some of the major investment options for beginner investors:
● Stocks (Equity investing): Buying a Stocks of a company lets you actually become part of the ownership of a company. To buy 100 Apple stocks is to become a shareholder in the great tech giant–this type of transaction means that your funds are directly tied to the valuation of the company you invest in. If Apple is perceived to be doing well (receiving a higher evaluation of share prices), your shares become more valuable: hence making a profit if you are to exit the trade.
● Bonds (Debt Investing): While stocks allow you to buy a share of the company, bonds are an opportunity to purchase some portion of a company’s debt. When companies are seeking to raise money, they may take out a loan to fund operations. These loans are to be paid back with interest, and banks (and governments) often sell portions of this debt to outside investors at a fixed interest percentage. Note: companies issue corporate bonds, while governments issue municipal bonds. It is also important to note that bonds are often considered safer than stocks because if a company is going bankrupt it first has an obligation to pay back its debt holders before it pays back its equity holders. If you manage to get the best bond funds, you can expect high but steady returns.
● Index Funds: Index funds are typically a low-risk investment opportunity. These funds offer a wide portfolio of companies, tracking a financial market index such as the S&P 500. Index funds typically come at very affordable rates, and are widely considered as one of the best ways to invest for the long-term–hence their widespread use in retirement investment portfolios. Some of the most popular index funds include the Vanguard Total Stock Market Index (VTSMX) and the Fidelity Total Stock Market Index (FSTMX).
● Mutual Funds: Mutual funds are pools of investor money that are managed by professional investors. These funds can be actively or passively managed, depending on the fund manager’s approach, and can vary in rates and fees significantly. While some of the top mutual funds can see returns upwards of 15% over five years, actively managed mutual funds are by no means guaranteed to beat the market and can result in a loss (especially after fees).
How and Where to Begin Investing
If you don’t already have a 401(k) or similar account from an employer (perhaps you’re self-employed), then the first thing you’ll want to do is open an investment account. If your goal is to save for retirement, then opening a traditional or Roth Individual Retirement Account (IRA) will be your best bet–this can be done at most banks and brokers.
Retirement accounts come with many restrictions on funds, however, so if your goal lies elsewhere then a taxable brokerage account will be more suitable. Don’t worry–it isn’t difficult, and many online brokers allow you to open an account without a minimum deposit requirement. Once you’ve opened your account, you’ll be able to choose from a variety of those investment options discussed above, such as stocks, bonds, index funds and more. While you may not be able to join Nitin Khanna in investing USD $5 million in a promising software startup right away, the earlier you begin investing, the more capital you’ll have available to grow in the long-term.
4 Tips for Beginner Investors with Nitin Khanna
● Know your fees: From transaction fees to deposits and commission schemes–perhaps the best advice beginner investors can follow is to gain a firm understanding of your broker’s fees. With research suggesting that just 1 in 20 actively managed local funds beat the market, it is not a naive investment strategy to simply find a fund or broker with the lowest fees. Many index funds are offered at low rates, and some are available with no minimum deposit.
● Less Attention, More Success: Despite the strong urge to do so, checking your portfolio obsessively will not help you make better decisions–in fact, research suggests that it may do just the opposite. Unless you are signing yourself up for the life of a day trader (looking to profit from arbitrage opportunities and daily fluctuations), our next tip for beginner investors would be to learn to be comfortable checking your portfolio no more than every quarter.
● De-Sanctify Diversification: Diversification is one of the holy commands of investing–and it’s one of the most useful instruments for mitigating risk. However, for beginner investors with a small amount to invest, diversifying your portfolio may not always be a viable option. With many online brokers charging $3-5 per stock trade, purchasing 10 separate stocks can set you back $50 before even getting started. If you’re investing a small amount (say just $500), that means you’re already down 10%.
● Business Competency (Nitin Khanna’s philosophy): For beginners who are looking to be more active in their investment decisions, Nitin Khanna has some broad advice on the types of companies he looks to invest in: those who can win the competency game. From the cannabis industry to software startups–potential is far from everything. If management teams aren’t able to deliver on a vision, then even the most promising ideas can fall flat; leaving your investment in the red. Nitin Khanna sold his first company, Saber Software to EDS for nearly four times its market value in 2008 at 420 million dollars. Nitin Khanna and his brother Karan helped manage the company for a few more years before moving on to start Mergertech, an M&A firm for technology companies.
Investing can be as active, passive, risky or cautious as you choose. And while it may not sound exciting to put away some of your hard-earned cash today so that you can enjoy significantly more in 10, 20 or 30 years–this is where the real discipline and benefit of investing lies. Though it may be rare to beat the market in the short-term, consistent developments in technology and company efficiencies through the decades mean that a long-term bet on the market’s success is typically a safe one.