Why You Should Treat Your Love Life Just Like Your Investment Portfolio
Working and dating in the finance world, I’ve definitely heard it all: “I’m like a one-sided balance sheet -- all assets and no liabilities”; “My interest in you is compounding by the minute”; “All your assets are AAA rated.” Then there’s pure genius: “You’ve Madoff with my heart.”
Let’s be real: When you think of sexy conversation topics, investing for retirement isn’t something that comes to mind. Instant gratification is a defining trait of Millennials, and living in the present is our generation’s mantra.
Don’t get me wrong; I love investing and even more when I’m engaged in intense dialogue. After all, what’s sexier than holding an undervalued stock that outperforms analyst expectations and yields an attractive price-to-earnings ratio relative to its peers?
Divesting and having those capital gains tax-free, of course! But you won’t catch me talking about rebalancing the asset allocation of my portfolio on a hot date.
Whether or not the idea of investing appeals to you, having a baseline assessment of how to invest is integral to maximizing an optimal financial outcome. Investing is like dating, and with enough experience, you’ll come across an investment you’ll want to hold.
Here are some high-level guidelines on where Millennials should start.
Before Strategy Comes The Basics
1) Choose An Investment Vehicle
Before you start investing, you need to know what accounts best suit your current financial profile. With dating, it’s akin to figuring out which traits in other people best complement you. The following are most common:
Roth IRA: Earnings from investments are tax-free, but contributions are made post-tax.
Traditional IRA: Earnings from investments are tax-deferred and contributions are made pre-tax.
401(k): Earnings from investments are tax-deferred and contributions are made pre-tax from a paycheck, offered by an employer and incentivized with a company match.
2) Show Me The Goods
Having too many choices can lead to bad choices. Case in point, my Tinder matches last week. If you’re just starting out, it's better to stick with the basics. For long-term investments, Millennials will want to know the following:
Equity Securities (e.g. stocks)
Debt Securities (e.g. corporate bonds)
Exchange Traded Funds, aka “ETFs” (e.g. basket of stocks/bonds/commodities that represents an index and is traded on an exchange, such as SPY, IWF)
Mutual Funds (e.g. pools together the money of many investors and is managed by money managers, such as a Target Date Fund, PTTRX)
What's The Game Plan?
Having a sophisticated investment strategy isn’t paramount, but knowing what your options are is key. Just as you would plan for a date, think thoughtfully about your approach to investing.
1) Index Investing
You don’t have to pick one stock or one bond. Broaden your horizons... and your dating pool, for that matter. For beginners, ETFs or Index Funds that track entire markets can be a much better choice starting out.
One example is SPY, an ETF that tracks the performance of the S&P 500, an index based on the 500 largest companies listed on the NYSE or NASDAQ. Doing so allows you to minimize risk by decreasing overexposure to one asset.
2) Sector Investing
Different sectors are affected by different things. At any given time, certain sectors will outperform others. In most cases, technology and healthcare tend to be the most rapidly growing sectors; whereas, consumer staples and utilities offer stability with moderate growth.
Certain sub-sectors tend to be cyclical, expanding quickly in prosperous times and contracting during recessions (e.g. media, automobiles), while other sub-sectors are non-cyclical (e.g. household products).
Diversify by investing in both cyclical and non-cyclical investments to minimize overexposing yourself to one group.
3) Value vs. Growth
These two approaches aren’t mutually exclusive; you don’t have to forgo one for the other. Assessing a company’s growth prospects is simply one aspect of benchmarking its value. Growth can be obtained at a reasonable rate where value is still maintained.
Value Investing: investing in companies that are undervalued by the market, and thus priced lower than similar companies (more stable)
Growth Investing: investing in companies with faster than average growth, and thus priced higher in the market (more volatile)
Talk Nerdy To Me
If you no longer want to keep it casual and want to get more technical, consider some widely used financial metrics, such as Price-to-Earnings (P/E), Debt/Equity, Free Cash Flow, Return on Equity (ROE) and Return on Assets (ROA), among others.
Take P/E for example. It’s the current price per share divided by earnings per share. It’s used to determine whether a company is undervalued or overvalued in comparison to its peers.
A higher ratio relative to peers means you would be overpaying with a premium; whereas, a lower ratio means the “intrinsic value” isn’t reflected in its market value, and you would be buying at a discount.
Investing can seem arcane, but it doesn’t have to be. Here are some key points to keep in mind:
Diversify: As Millennials, we should have a more aggressive approach to investing by allocating a significant portion of our portfolio to securities where there is more upside (e.g. stocks) and less in securities that yield a fixed stream of income (e.g. bonds).
This is because at 25, we’re allotted more time to recover from any financial setbacks than someone at age 50, who is much closer to retirement.
Fees: Be fee conscious; it’s all about net capital gain. When investing, be cognizant of expense ratios (fees related to funds), transaction fees (for executing a trade), annual account fees and investment management fees, among others.
Past performance is not a guarantee of future returns: Nothing is guaranteed. That awesome date you had two weeks ago may have been a one-off occurrence. The same goes for historical investment performance. However, sometimes you might just be pleasantly surprised by those who exceed your expectations.
Happy dating... err investing.
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