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The Basics of Investing

By Jeff Greenspan, Managing Director, Financial Modeling Services

Many people consider investing to be confusing, but it doesn’t have to be. The most important thing to know about investing is that time is your best friend and worst enemy, so don’t wait to GET STARTED! Here is an overview of everything you need to know to invest with some degree of competence. Let us start with a few definitions.

INVESTING: The process of setting money aside for the future with the hope that the money that is set aside can grow and have more buying power than it does today.

ASSET: Anything that has value. From an investing perspective, assets should generate a positive return over the time period of the investment, meaning they are worth more in the future than you are paying today. Your personal home is not generally considered an investment asset.

ASSET CLASS: A set of assets that are similar. Examples include stocks, bonds, real estate, and cryptocurrencies. Note that most asset classes can be subdivided; for example, stocks can be broken into large cap vs small cap, or international stocks vs domestic stocks.

RISK: All investing contains an element of risk, no one can predict the future, and past returns are no guarantee of future results!

Because EVERY investment has risk, and because the market price of an investment already incorporates the perceived risk of that investment, investing in only one stock is almost the same as gambling! You have no idea what direction that investment will go.

The rest of this document will focus on the stock market. Though a prudent investor will also want to own real estate, business(es), or alternative assets, you have to get started somewhere, and it is easy and reasonable to get started in the stock market!

The quickest, easiest way to invest in the stock market is to invest in one or more Exchange Traded Funds (ETFs). These index funds attempt to replicate an entire asset class or subclass. Table 1 below lays out the five primary asset classes, suggests one or more representative index funds, and displays the returns and volatility for each fund for the period from 10/17/2019 to 10/16/2020. Note that higher annual returns are almost always associated with high volatility (risk). Your job is to pick fund(s) based on your tolerance for risk. Note however that high risk isn’t always bad depending on your time frame! If you are investing for the long term, higher risk investments should provide higher returns.

Table 1: ETFs representing the five major asset classes and their annual returns: 10/17/2019 to 10/16/2020.
Asset Class ETF Ticker Returns – Volatility
U.S. Equity Russell 3000 - The largest 3000 U.S. stocks IWV 19.24% - 34.68%
Fixed Income Barclay’s Aggregate Bond AGG 6.97% - 8.4%
Barclay’s TIPS Bonds (inflation protected bonds) TIP 10.07% - 8.9%
International Equity MSCI EAFE - developed market index EFA 0.19% - 30.37%
MSCI EAFE SM - EAFE small-cap stocks SCZ 5.09% - 30.1%
Emerging Markets MSCI EM - emerging market index EEM 10.81% - 33.52%
Alternative Classes Dow Jones U.S. real estate index funds IYR -10.93% - 40.58%
SPDR Gold Share GLD 26.94% - 18.43%
GS Connect Commodity GSG -27.24% - 31.99%
United States Oil Fund USO -68% - 69.83%
Bitcoin GBTC 42.46% - 85.06%

Academic studies point to two methods of investing that generally result in higher returns over time. See https://www.investopedia.com/articles/stocks/07/dcavsva.asp for more information about these two methods:

There are also several types of accounts for your investing:

Resources:

Investopedia: www.investopedia.com is the first place I look for definitions and straight-forward explanations.

Yahoo Finance: finance.yahoo.com provides financial news, data and commentary including stock quotes, press releases, financial reports, and other content.

Marketwatch: marketwatch.com provides financial information, business news, analysis, and stock market data.