Art and Finance website: https://artandfinance.net/
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Assistant: Mack Agbayani
I’m Ramon Cuenca, founder and director of Art and Finance, the website that makes learning Finance fun and accessible.
This is the final video on our mini-series on Personal Finance. In this episode, we’ll be talking about how to get your money invested. After all, what’s the point of learning about reward, risk and constraints if you don’t know who to talk to open an account and what kind of investments you can consider?
(Episode #6: Personal Finance Basics: How To)
There are many ways to go about investing, but let’s get this out of the way first: Most of you watching this video should not do active investing, which is to actively pick which particular asset classes, which particular stocks or bonds, et cetera et cetera to buy for your personal portfolio. Trust me, it’s not worth it unless you go into it full time and do all the research necessary. So if you’ve got a full-time job, opt for passive investing instead rather than active investing.
Passive investing means buying and holding assets that reflect the overall market, i.e. all the different publicly traded financial assets available. Examples of such assets include index funds, which are pooled investment vehicles that replicate an index, and exchange-traded funds (ETFs for short), which are similar to index funds but can easily be traded on a public exchange, similar to stocks.
Fortunately, today’s technologies makes it easier than ever to do passive investing. Recent years have seen the rise of “robo-advisors”, which are basically companies that use technology to determine the best asset allocation strategy for you and invest your money accordingly. You simply log on to a website like Wealth Front and fill out a questionnaire which determines your risk profile, which in turn helps Wealth Front’s computers develop an asset allocation strategy for you. Normally, sites like Wealth Front will invest your money in a group of index ETFs that reflect your risk profile. I’ve included some robo advisors in the description.
If you want to do passive investing but automated asset allocation isn’t your thing, you can always invest directly in index funds or ETFs through a broker. For individual investors, you can choose between two types of brokers – full-service brokers and discount brokers. Full-service brokers provide you with advice and assistance, along with execution of trades. For those who can formulate their own investment strategy, discount brokers provide trade execution at lower costs but no real investment advice or assistance. I’ve included some of the biggest brokers in the description.
Now, for those of you who want to do active investing and try and beat the market, there are several options for you.
The first is outright buying stocks and bonds and building your own portfolio from there. You can go through either the full-service or discount brokers to do this. Another option is to invest in mutual funds, which are pooled investment vehicles whose goal it is to earn a higher return than a particular benchmark, for example a US stock mutual fund that is tasked to outperform the S&P 500. Lastly, if you have a lot of money, you can hire an investment manager to manage your assets full time.
A quick word on alternative assets. Most of the time you as an individual investor won’t have access to the majority of alternative assets, as they often carry a high minimum investment amount. Luckily, ETFs that track alternative assets are available these days, so this is one option for you. Additionally, if you like real estate in particular, you can also buy what are known as real estate investment trusts, or REITS for short. These are publicly traded shares that represent investments into various real estate assets.
Whether you decide to go passive or active investing, there are a few real-world issues you may have to consider.
The first is transaction costs – specifically, the fees you have to pay brokers every time you trade. The more you buy and sell, the more fees you have to pay.
Related to transaction costs is rebalancing. For example, if you want and have a portfolio of 60% stocks and 40% bonds, and suddenly your stocks go up in value, you could end up with a portfolio with a larger weighting toward stocks. You would have to sell those stocks to maintain your target 60-40 allocation. This is an example of rebalancing, and it involves transaction costs. One way to reduce these costs is to allow your portfolio to drift slightly from your target allocation. Also, rebalancing is less of a concern with robo-advisers, since it’s done automatically and is part of the annual fee you pay.
If you invest in funds, something you have to watch out for are management fees. Ideally, you would buy into a mutual fund instead of buying its benchmark (via an index fund or ETF) with the hopes that the fund would perform better than the benchmark. However, a mutual fund’s performance may actually be lower than the benchmark, once you factor in fees that you have to pay to the fund manager, in addition to other fees you may have to pay.
Minimum investment amounts may restrict you from buying particular assets. We mentioned the high minimum investment amounts of alternative assets earlier, but even more traditional assets like bonds can command a minimum investment of several thousand US dollars. One way around this, again, is to invest in funds or ETFs that track bond performance.
One last thing to consider, if you’re thinking of hiring a financial advisor. Look for advisors who have qualifications that hold them to fiduciary standards. A fiduciary is “someone who occupies a position of special trust and confidence with the responsibility of acting in the best interests of an investor.” (from Investopedia). Qualifications such as being a registered investment advisor (RIA for short) requires by law that the advisor follows fiduciary standards. Contrast this to a stockbroker, who may give you stock advice, but may be paid by commission to sell you all sorts of investment products.
And that’s it for our mini-series on Personal Finance basics. Please do check out the links in the description for further information. In our next video on 8 May, we’ll return to our regular format of learning about economics, finance, and business. Here’s a hint of what we’ll be talking about – can you guess what it is? You’ll find out soon!
Ramon Rodrigo Cuenca, CFA
Art and Finance
Assistant: Mack Agbayani
CFA Curriculum Level III, volume 4, pp. 14-15