Step 2 – Investing Basics
December 29, 2020
Once you’ve secured the basics (which I talked about in my previous post), It is time for Investing 101. Most people think that investing is a rich person’s game and that is as far from truth as can be. In fact, it is the exact opposite. People don’t invest because they are rich. They become rich because they invest. From my perspective,
“Investing is the process of converting cash into cash flows“Sanjog Patel
While this definition is very simple, it consists of a lot of nuance which I want to try and unpack in this article.
- The presumption here is that you invest when you have cash –
- No matter who you are, NEVER use debt to finance a personal investment (with the exception of your house), no matter how sure you are of the payoff. All investments carry risk and the risk/reward equation just doesn’t work except for your house because your house provides you with a very necessary utility. I’ve written a post dedicated to home buying using debt as an investment here. You want to convert cash you have to invest. Not cash you borrow. Not cash you could use to payoff debt. Only cash you have AFTER you’ve secured the basics I talked about in the previous post.
- Investments should generate cash flows (especially when you are starting out) –
- When you start out, you should focus on investments that will generate free cash flows. Stocks that pay dividends, properties that generate rent etc. Something that allows you to park a sum of money (ideally with appreciation of the parked money) and then generate some cash dollars from time to time. You can use those cash dollars to either invest in something else (called diversification), cover an unexpected expense or reinvest in the same investment but the fact that you have that choice is a very valuable proposition to have.
- The term ‘cash flows’ implies that the investment will have a long term perspective –
- Investing in general requires a long term perspective. While temptation to chase a stock with a lot of media coverage in the information age is everywhere, and FOMO (fear of missing out) rules supreme, I promise you that while you may be able to make a payoff work in your favor once or twice, this is not an investment strategy. Even slot machines pay off once in a while but that is called ‘gambling’, not ‘investing’. Investing demands patience, discipline and dogged study and research. So learn, think and once you’ve made a knowledge based decision, persist. It will pay.
- The term ‘cash flows’ also implies that the investment will have residual value –
- Anything that can go down to zero any minute, is not an investment. When you buy a stock, the company has a business model that more than likely generates profits and cash flows and owning stock (being a partner) entitles you to a portion of those profits. More importantly, it also entitles you to a share of the assets the company might own (like buildings, cars, planes, furniture, factories, inventory, brand etc). All these real assets have value and you own a piece of it as a shareholder.
- The term ‘Investment’ is thrown around very loosely in today’s day and age. One of the biggest pet peeves I have, is people saying they are ‘investing’ in crypto. Buying Bitcoin is not an ‘investment’ since bitcoin has no inherent value. Bitcoin is a ponzi scheme in my opinion. Its value is driven entirely by what someone is willing to pay for it. It is not a business that generates profit and has no residual value as an asset. You may argue that it does based on the fact that it has gone up in value in recent times but so did Tulips during the Tulip Mania until Feb of 1637. Tulips still had some value though since you could plant them and have pretty flowers. Bitcoin wouldn’t even entitle you to that when the bubble bursts.
- Now don’t get me wrong. Blockchain as a technology is promising and has utility. But it is not a currency. If Bitcoin was the currency of the United States when COVID hit, the government would have no capability to provide stimulus since they would not be able to create more Bitcoin (but they can print more dollars). I will write a detailed article on cryptocurrencies at a later time but if you ask me, cryptocurrencies are inherently worthless.
Now that we have those things established. Start thinking about what ‘Investing’ means to you and let me know in the comments. What are some of the investments you like. Real Estate? Stocks? Bonds? Why?