Investing Beginners FAQ at Shrewd'm

Personal Finance Topics / Investing Beginners

What happens if you just read books, play games or pursue important vocations, and whilst living life so fully, you also simply ignore money completely - you simply imagine that it doesn't exist.

What will will happen is that the bills will pile up, and you won't be able to pay them. Think of this as there being a constant negative cash-flow in your life, unless you are working. If you sit still, and cash savings that you have decreases slightly each day.

How can this be overcome? If you own a small share of a business, then it is possible to not be involved with the business at all, but when you repeat the above exercise, the business will continually pay a small dividend to you. So as you sit still, the is some small positive cash flow each day from the business (even if it pays out only every 3 months).

What happens if this dividend is as large as the negative cash flow that we talked about in the second paragraph? In this case, you can continue to do what you want and you won't have to think about work, other than your vocations which you are likely far more important (not only for you, but possibly even to culture or society).

Now, sadly, it isn't that easy to own a business large enough to pay your expenses. But what I am trying to illustrate is that you always have a constant negative cash flow from life and a positive cash flow from investing, and if you can build your ownership of business large enough, the positive cash flow can at some point catch up to, and then exceed, the negative cash flows.

What you will hear all the time is that investing involves taking on some level of risk. You will hear that there is no guarantee of a return on your investment, and there is luck involved, or you had to get in at the right time and have missed all the past opportunities.

Thankfully this is not necessarily case. Much of these discussions relate to the changing quotation of investments, which indeed is all over the place - think of the quote as changing randomly each year - but over the long-term, particularly if you own a basket of businesses with a low-cost index fund, you will receive an average 30-year return in the range of 4% to 8% above inflation. You can build your business ownership starting at any time - even if some entry periods will offer a higher return, all entry periods will provide some return in the form of dividends over the very long-term.

How do you build up this business ownership? You use a discount broker (just Google this term and you'll have dozens of them throwing their arms up trying to get your business). You set up your account, send some cash to your account, and purchase shares of the business that you would like to own, or shares of an index fund. Your cash disappears at this - try to not pay attention to the changing quotes, but think of what you own now as the business itself - it takes many years for business to produce cash and grow, so try to get away from the idea that there is this quote moving up and down each day. Forget it - you don't have the cash anymore, and instead have a permanent share of the business.

Some business will offer a higher investment return over the long-term than others. The advantages of various businesses purchases, and index funds, are discussed throughout Shrewd'm. A good place to start is the Berkshire Hathaway board - the community is exceptionally helpful and friendly here, so definitely do not be afraid to ask the most simple questions. Actually, as a rule of thumb, the more stupid, the better.

Many investors believe that the market is inefficient, and that by focusing on a company's fundamentals, such as earnings, cash flow, and assets, they can identify stocks that are selling for less than they're worth. Other investors believe the market is efficient, so it doesn't matter which business you buy - they'll all have about the same return, with the higher returns requiring wilder fluctuations in the quote over the short-term. This distinction can be bypassed completely by simply buying an index fund, such as S&P500, or the equal-weight index fund RSP which over the past 100-years gave a return 1% to 2% higher than the S&P00.

The single concept that nearly all enthusiastic investors learn very early on is the effect of compounding. You basically either become excited by the idea, or you don't, and there is something to be said for this being the filter as to who will become an investor and who won't. Here's the test - if the idea excites you, there is a good chance you are already an investor at heart. Imagine adding up your savings of (let's say) $1,000 per year. Pick up a calculator, or load a graphical one, and type 1,000 + = = = and repeat = many times. You'll see how your savings builds up each year. Now do something similar. Type 1000 * 1.08 = = = = and again repeat =. That is your savings with an average 8% gain each year. Rather soon, the figures start to ballon past the earlier calculation. And guess what - in the first example you committed $1,000 every year, and in the second example you committed $1,000 only in the first year. The effect balloons much more if you continue adding savings to your investing. This demonstrates how capital compounding (from investing) will always exceed linear savings (from work) if enough years can pass. This is also why it is extremely advantageous to start early with investing.

Nearly all of the discussions about investing are about what tricks to apply to get a better performance than everyone else. That's the nature of the human competitive spirit. However, it is important to not miss the big picture: It is the participation of investing over the long-term, and merely accessing an average return, which distinguishes most successful investors from the unsuccessful ones. Many investors enter and leave the market at various times, and their average time in the market can be only a portion of their life - not enough time for the savings to really compound.

Investing requires the avoidance of costs (just like running any business), and above all, it requires extraordinary patience. It does require discipline, but not the type you might think - it doesn't require hard work, so much as a mental discipline connected with patience and indifference to both the depressed mood of markets and the euphoric moods. It is these mood changes, and changes in the news sentiment, that causes investors to enter the market when the prospective return is low (the quotes high), and exit the market when the prospective return is high (the quotes low).

This board is a place in Shrewd'm where no question relating to investing, not matter how basic, is off limits.If you are new to investing, you have come to the right place.

Welcome to the exciting world of capital compounding, the reading of accounting, the pragmatic understanding of various types of business, a fascinating life-long study of psychological biases and other philosophical readings, and most importantly, welcome to a world where you will forever seek to nurture your greatest treasure - your invaluable curiosity.

Shrewd on.

- Manlobbi