The $1 on your bedside table became .05% less valuable today. Well not exactly… inflation doesn’t work quite like that. But over time, all currencies slowly decrease in purchasing power.
Inflation is a hotly debated topic and complicated to calculate, but the generally accepted view is inflation averages around 2% per year. Aka your money generally becomes 2% less “valuable” every year. But wait! Before you throw all your cash into the ocean out of rage, there are solutions to this!
As a business school kid who didn’t venture far off West Campus my last few years at A&M, the vast majority of my friends have taken quite a few finance classes. If that applies to you, the next few paragraphs are going to seem outrageously simplified and I apologize for that! My goal of this article is to help people with limited finance backgrounds:
1. Understand what investing options they have
2. Understand the risks/historical performances of each option
3. Feel comfortable deciding their own investment allocations based on their personal needs and risk tolerance
When people talk about investing, they are generally focusing on the stock market. The Stock Market is essentially an opportunity for people to buy portions of everyday companies they interact with on a daily basis. A company like Amazon is divided into lots of slices called shares, each of which are available for purchase. For example, there are around 504 million shares of Amazon with a price of $3,600 per share for a total value (Market Cap) of $1.8 trillion (504M x 3600). You can also buy portions of shares (1/10th of an Amazon share for $360) if you want. Additionally, you can buy collections of groups of stocks in different industries or even the entire market. These collections are offered through Mutual Funds and can help minimize the volatility of owning individual stocks. People also often refer to the S&P 500 which is a collection of the 500 biggest US companies that you can invest in and the NASDAQ which is a collection of technology companies. In concept, the price of a share of a company will go up if the company earns more money or investors are more excited than previously about the future of that company’s earnings. Stocks over the last 100 years have had the highest average return of any asset, averaging an 8% annual return. They also have increased volatility compared to cash and bonds.
Bonds are also an investment option in addition to stocks. Bonds are corporate debt where a company or government gives you an “I owe you” and will pay you back more over time. Currently, Exxon has bonds where if you pay them $100 now, they will pay you $109.53 in 2024. (Yes, Finance people, I realize it’s more complicated than this, plz stop rolling your eyes). Under this deal, you could make ~3% annual returns on your money, assuming Exxon continues to operate as a company and more importantly- learns that Zoom has a record function. Similar to IOU’s with friends, investors require higher interest payments to buy bonds from riskier companies. Amazon, a company with a low chance of going bankrupt in foreseeable future, often pays below 1% on bonds while Tilray, a Cannabis company with a more risky future, has to offer bonds with a 5% interest rate. Bonds are generally more attractive to older investors who are more focused on wealth preservation and have more need for the dependable cash payments of bonds into retirement.
So does this mean you should not own cash at all? I wouldn’t recommend that until your local Trader Joes accepts your Robinhood login info as payment. Ultimately, you still need cash for daily expenses. I also recommend holding a certain amount of cash in a bank account for emergencies. The general Rule of Thumb here is saving 3–6 months worth of expenses, though this varies based on your risk tolerance. The key is having a safe amount of “liquid” assets.
Liquidity of an asset describes how quickly it can be turned into cash in an emergency. Seen to the left, Cash is the most liquid asset. Other assets like real estate and retirement accounts are considered less liquid as they are harder to sell quickly. In between those are stocks and bonds, which are often “3 Days Liquid” as in it takes 3 days to convert to cash in your bank account. Knowing the best mix of liquid and illiquid assets depends on your personal life (family vs. single, current job, cost of life).
Deciding your personal allocation percentages for different investing assets relies on 2 main things
1. Your age
2. Your Risk Tolerance
At a younger age, you are likely further from retirement and should be focused on highest average returns, regardless of risk. Given that my average reader isn’t close to retirement, the vast majority of your portfolio at this time should be in stocks. Now which stocks? I would argue a vast majority of your wealth should be in indexes tied to the overall stock market to minimize risk while capturing the greatest expected return. Common indexes track the S&P 500, the NASDAQ, or industry specific stocks. Look for overall market funds with low expense ratios and invest the majority of your earnings there. Stocks also have the highest risk of these assets. Overall Stock Market dips of 10% are not uncommon, so invest knowing that volatility is expected and unavoidable. I would also encourage some degree (personally around ~20%) of individual stock buying. I have found this is the best way to learn more about the market in general, and build more personal curiosity in finance. Skin in the game is powerful.
Lastly, it is imperative that you start investing as early as possible to capture the benefits of compounding interest. This is honestly the most important topic of this entire article. It’s nothing more than simple algebra, but the math impacts portfolio returns tremendously. Assuming a consistent rate of return, early saving has an outsized impact on your overall investments when you retire. It is so important to start the compounding process as early as possible. And if you don’t believe me, maybe two of the leading minds of the last century can help convince you (only one of these was photoshopped)
Lastly, investing is all a learning process. Below are the resources I read/watch the most. I would LOVE to hear anyone’s thoughts on this and welcome any discussions about investing strategies/finance in general.
Helpful resources to learn more:
Best Twitter Accounts
Ben Carlson
Andrew Ross Sorkin
Trung Phan
Michael Batnick
Douglas Boneparth
Tracy Alloway
Joe Weisenthal
Matt Levine
Stratechery
Cathie Wood
Vitalik Buterin
Patrick OShaughnessy
Balaji Srinivasan
Chamath Palihapitiya
Packy McCormick
Dan Primack
Ben Thompson
Modest Proposal
Josh Brown
Aswath Damodaran
YouTube Videos
The Compound Channel
How The Economic Machine Works by Ray Dalio
Best Articles
Literally Anything written by ARK
Not Boring
The Bullish Case for Bitcoin
Bull Case for Ethereum
Great Article
Best Podcasts
I didn’t expand a ton on Alternative Investments above and wanted to here. I am personally a huge proponent in investing in Cryptocurrencies and also see value in other alternative assets such as real estate and art. I wanted to focus mainly on intro investing. I definitely see value in allocations to Bitcoin and Ethereum in portfolios but didn’t want to deviate too far from intro stuff. The normal risk caveats would only be exacerbated for these assets, the volatility is extreme but the upside is extreme. For another post I guess…
