Preparing to invest

Key topic

In this lesson we will go through the process of getting prepared to invest and we will pinpoint what to look for and what the risks are. We will also look into the importance of investment diversification and we will go over real estate investing. At the end of the lesson, we will present the ‘Being Investment Prepared’ Checklist which will give you an idea as to when you will be ready to start investing.

Learning objectives

• Develop a good understanding of the process and outcome of investing
• Be aware of fraudulent investment schemes and advisors
• Understand the basics of investing in the real estate market
• Learn all about investment diversification

Preparing to invest

Investing makes sense. It’s all about making your money work for you, instead of the other way around! Best of all, the sooner you begin investing, the more you can increase your original investment – at least in theory. In addition to learning basic investment concepts and definitions when preparing to invest, you have to also become mentally ready for investing.

Be Consistent – The first step to achieving financial success is following a consistent, long- term investment plan. A regular savings plan can be the foundation of your investing career as it provides you with money to invest on a regular basis. Financial success takes time, so you need to take the long view, and not focus on short- term gain. If you start investing early and consistently, you will be able to take advantage of the power of compounding interest.

Have your emotions in check – Emotions make us do things we wouldn’t normally do. This is especially true with investing. The negative emotions most likely to affect people when they invest are greed and fear. Many people just concentrate on getting more and more money, but when they start to lose money, they become scared and freeze up. Another mistake people make is getting emotionally attached with a stock, or a company, or a piece of real estate. Despite warning signs telling them to sell, they foolishly continue to hold on to it, even as it depreciates in value!  If you carry emotional baggage, you are more likely to make bad decisions than people who have a clear, relaxed business focus. You should be aware that controlling your emotional responses to risk is an important part of your investment plan.

Look at the bigger picture – You should not just focus on the ups and downs of each individual investment; always step back and look at the big picture. One of the biggest things to watch is trends. A trend is the direction toward which a market tends to move. By looking at trends and building your knowledge of trends, you will be able to assess the quality of the investment options presented to you. To invest in companies or markets, you need to know whether they have any problems. General research can help you find out if there are problems and you will get a better understanding of why this stock is tumbling, or that housing market is rising.  Since the final decision will always be made by you when investing, you need to keep an open perspective and keep educating yourself on the surrounding facts of the investment markets.

Now let’s look at some tips on how to go about investing, from NFL running back Arian Foster:

1.Start with the end in mind

Look at each contract like it is the last one you will ever sign, because you never know when your run in sports will be over.

2. Invest in companies that align with your beliefs

Every investment is rooted in my personal conquest to help people live better lives. You can do good by doing good.

3. Invest in great human spirits

The world is full of great ideas, the execution is where the brilliance is and that takes a great leader and a great team.

4. Be part of companies where you can learn too

If you can make sure that with each company you work with, you can get your hands dirty and learn the business, that wisdom alone will always be a great rate of return on your investment.

5. Know who to trust… and trust them

Find mentors, you can’t go it alone; surround yourself with people you trust who are experts in areas you are weak in and then, listen to them when they give you advice.

Be careful of investment fraud

During your career you are going to be surrounded by people offering you “Get rich quick” schemes. People will be calling you with a “hot” stock tip or urging you to invest in a sweet deal. These salespeople are trying to affect your emotions by selling you an unlikely dream. Some examples of fraudulent investment schemes are Ponzi schemes and the Madoff case is a good example of such a scheme.

Bank frauds, and accounting frauds such as the Enron collapse are also forms of fraud that you need to be aware of. By gaining the necessary knowledge of how these schemes have worked in the past, you will be able to make educated financial decisions for yourself.

It’s not bad to listen to other people’s investment ideas, but never go through with one before doing your research and discussing it with a trusted advisor. A clever way to filter people who approach you with an investment idea, is to ask them to send the relevant information to your attorney, accountant or financial advisor. If they don’t, you know that you have steered them away!

In the past couple of decades, we had several fraudulent investment schemes in which a lot of money was invested and lost. Unfortunately, these types of schemes come in a lot of varieties and flavors, so we have to be extra careful. Having knowledge about these fraud cases of the past, may help you in identifying similar characteristics in any investment proposals you may get in the future.

A Ponzi scheme is an investment fraud where people invest and their return on the investment is paid from the money of new investors. So basically, a Ponzi scheme is a type of fraud in which belief in the success of a non-existent enterprise is fueled by the payment of (typically) quick returns to the first investors from money poured in by later investors. So, people who invested in 2012 were paid their return using the investment money from  people who invested in 2013. Therefore, you need to beware of the promise of unrealistically high returns. For example, person A invests $1million and is promised $100,000 in a year. Then person B invests $500,000 and the fraudster uses person B’s money to pay person A their $100,000. Person A seeing the huge returns gets excited and may even end up investing more money.

Another case of fraud, involved Enron, a U.S. energy trading company, that went on to carry out one of the biggest accounting frauds in history. Enron’s management utilized accounting practices that distorted the company’s revenues, which, at the height of this fraud, turned the company into the seventh largest firm in the United States. However, once the fraud was uncovered, the company collapsed and filed for chapter 11 bankruptcy in early December 2011.

Former Miami Dolphins cornerback Will Allen and his business partner Susan Daub set up a business, Capital Financial Partners, in 2012 and recruited investors who thought they were making short-term, high-interest loans to professional athletes who were waiting for their contracts to kick in during the offseason.  They used investor money for their personal benefit and to pay other investors, including pro athletes, but they also diverted money to other ventures. Allen and Daub were sentenced to prison and ordered to pay restitution totaling $17 million, for running a Ponzi scheme that took in more than $35 million.

With the help of a financial advisor, always check out the history of companies that you intent to invest in.  Do not look at companies just from the outset!  It is important to understand the value of the underlying assets of a company.  For example, if you invest in a company that owns and rents out a real estate complex, you need to understand what gives this complex its value. Is it its location?  Is it its architecture? Or, is it just that currently real estate prices are overestimated?

Action Steps – Exercise 1 (5 Minutes)

• What do you think about the Will Allen case? Are you aware of any other such fraudulent schemes?

How investments work

Choosing an Investment Advisor

An investment advisor plays a huge role in the success of your investment plans. You need to exercise great care when choosing an investment advisor since this is the person who will be guiding you on how to achieve the financial results you need to attain financial freedom.

The best advice that we can give you, is to educate yourself on basic financial and investment concepts so that you are in a position to evaluate the advice given to you and make financially sound decisions. We reiterate that, basic financial knowledge can really save the day when it comes to financial decisions with a lifelong impact! By being aware of the basic principle that the riskier the investment, the higher the potential return, enables you to make some basic financial decisions.

Following his retirement, former San Antonio Spurs athlete Tim Duncan lost more than $20 million to Charles Banks, a corrupt financial adviser. Duncan met Banks, a private-equity investor in 1998 while he was still a young upstart. Banks convinced Duncan to invest several million dollars in hotels, beauty products, sports merchandising and wineries, that Duncan owned or had stakes in. Banks didn’t disclose that he had serious financial interests in those entities. Moreover, Banks also defrauded him through a $7.5 million loan to Gameday, a company controlled by Banks. Gameday later also obtained a $6 million loan, with Duncan alleging his signature had been forged. A federal judge handed down a four-year prison sentence to Banks for ripping off the retired NBA star and also ordered him to pay Duncan $7.5 million in restitution.

How does buying and selling stocks work?

During trading, stocks are bought and sold by bidding. When the bid price (price at which buyer is willing to buy) and ask price (price at which seller is willing to sell) match, a sale takes place. This means that prices can fluctuate day-to-day and the worth of the stock you own can change, depending on the demand for the company’s stock. The stock market moves based on prices at which people are offering to purchase a stock.

A stockbroker is usually the middleman in any transaction as they buy or sell stock on your behalf. In addition, stockbrokers may also offer advice to their clients on which stocks to buy.

Street talk
Wall Street has its own ‘language’ and we set below a few of the most common terms:

• Share — A share is an ownership unit of a company issued to shareholders.
• IPO —Initial Public Offering (IPO) is the first sale of a corporation’s common shares to public investors. The main purpose of an IPO is to raise capital for the corporation.
• P/E Ratio —The price/earnings (P/E) ratio represents a stock’s present price in relation to its per share earnings from the past year.
• Bull Market – A period of generally rising share prices which encourages buying. The start of a bull market is marked by widespread pessimism. The feeling of despondency changes to hope, optimism, and eventually euphoria, as the bull runs its course.
• Bear Market – A period where share prices are falling and where selling is encouraged. A bear market is typically shrouded in pessimism and the economy typically slows down.
• Market Correction – Corrections are generally temporary price declines interrupting an uptrend in the stock market. A correction has a much shorter duration than a bear market.

The real estate market

Home ownership, as an investment, provides a number of benefits, but like all major purchases, buying property takes planning. First you need to have a working budget in place so that you know how much you can truly afford to invest in real estate. Financially successful people are the ones who make sure they can really afford a purchase before they buy.

The benefits of property ownership

• Leverage — As a property owner, you have the ability to control a property of greater value than the cash you originally invested. You gain leverage by borrowing money and controlling a much bigger asset than the money you have originally paid.
• Equity Growth — Paying down the principal balance regularly gives you a steady equity growth. Each time you make a mortgage payment you pay down a portion of the balance you owe.
• Tax Benefits — Real estate owners have many available tax benefits.
• Appreciation — Appreciation is a real estate term used for the increase in value of land and buildings. If you purchase a house for US$200,000, for example, and the property appreciates 10%, the value of the house is now US$220,000. If it appreciates 10% again the next year, the value grows to US$242,000.
• Higher Return on Investment Potential — Given the leverage real estate investment offers, and the fact that your investment appreciates on the total property value, your ROI could be much higher than you would have encountered with other investments.
• Cash Flow — Rental property owners generate cash flow via monthly income they collect from tenants.

The risks of real estate investing

• Liquidity — Selling a property can take years, depending on market conditions. When the market is strong, the average time to sell in most communities is two to six months. In bad market conditions, the property can be listed for years before it sells.
• Change in Loan Market — Lenders can change their rules at any time. Changes in loan terms affect future buyers and your ability to sell the property.
• Market Conditions — Fluctuations in market conditions can quickly change your situation. It’s important for property owners to view the long-term market outlook.
• Maintenance— Repairs on a home can be quite costly. You need to have enough money saved and the right insurance so that you’re adequately prepared for contingencies.

Breaking It Down

Below is a sample budget for purchasing an investment property. You should understand the importance of budgeting and being financially prepared before purchasing any investment properties.

Here’s an example of potential costs to include in your budget:

Some costs — like taxes and insurance — may increase or decrease. You must budget out a few years in advance when considering the cost of home ownership.

Let’s watch a 2-minute video from Investopedia on real estate investments.

Investment Real Estate

Investment diversification- Do not put all your eggs in one basket!

What would happen if you had all your money in real estate and the real estate market collapsed? Sounds familiar right? During the Great Recession of 2008 in the U.S. this is exactly what happened with real estate values going down by a staggering 30% plus!

Most top investment advisors will recommend that you diversify your investments to  protect you from losing everything. Diversification means that you put your money into several different types of investments that are unlikely to all move in the same direction. For example, you might spread your money across stocks, bonds, and real estate. When the value of one investment goes down, one of the others might go up, so you either have  better returns or reduce your overall losses. Furthermore, by diversifying your portfolio, you remove any form of idiosyncratic risk which is the risk associated with a single stock. For example, if you hold a single stock of let’s say Tesla, you bear the risk of the Tesla stock price falling.  When, on the other hand you own 100 different stocks, including Tesla, the risk that you bear when the Tesla stock price falls is negligible given that you have 99 more stocks in your portfolio of investments.

Diversification can be an important step towards developing a successful investment formula and a winning portfolio. An investment advisor can help you make qualified diversification decisions. You should consult with an advisor about how best to spread your money around to reach your long- term goals. There are four different types of diversification:

• Diversification BETWEEN different asset classes; i.e. real estate and shares. When you allocate assets into different asset classes such as shares, real estate, cash, bonds, etc. you balance risk and potential rewards.
• Diversification WITHIN an asset. For example, real estate can be diversified between owning residential and business properties or, investments in shares can be diversified between large established companies and small start-ups.
• Diversification ACROSS industries, countries and currencies around the world. When you allocate your shares portfolio across different industry sectors you will be able to monitor and balance the impact of each industry sector on your portfolio. Also, spreading your equities across different countries and currencies, contributes to risk balancing and potential maximization of returns.
• Diversification ACROSS time; just keep adding to your investments systematically over the years and you will increase your returns while reducing your risk. This is called Dollar Cost Averaging and it is an investment technique through which you buy a fixed dollar amount of a particular share on a regular basis, regardless of the share price. The goal of this method is to reduce the impact of volatility on large purchases of shares and protect the investor against market fluctuations.

There is no generic diversification model which can be a perfect fit for every investor. Each investor has different characteristics which should be considered when forming a diversification strategy. These characteristics include the investor’s financial goals, time horizon, risk tolerance, investment expertise, need for liquidity, etc. For example, a mature athlete’s investment horizon may be 5 or 10 years whereas a rookie athlete’s time horizon may be 20 or 30 years.  Also, a mature athlete is naturally less of a risk taker given that their investment time horizon is limited. So, diversification is not a one-fit-for-all strategy, nor a one-time task. A proper diversification strategy should always align with your particular circumstances and characteristics; it should be continuously monitored and periodically adapted to make sure that it continues to make sense.

So, remember: A proper and flexible diversification strategy, periodically adapted to your changing needs, is key in building a successful investment portfolio and ultimately achieving financial freedom!

We will now watch a 2-minute video which recaps what we discussed above about investment diversification.

The Importance of Diversification

Becoming investment prepared

Through investing, you are getting your money to generate more money and over the long term, you benefit from potentially higher returns than you get from a savings account. With a proper investment strategy, which you can set up with the help of a financial advisors, you can use your money to build up your assets and use them toward the major financial goals you have set, such as buying your dream home, buying your dream car, starting your own business, or travelling around the world.

Investing nowadays is not simple and requires investors to be constantly educated and informed on the variety and complexity of investment vehicles available. If you choose for example to invest your savings in the financial markets, you have the opportunity to benefit when companies perform well, or if you choose to buy and sell real estate, you can benefit from their increase in value. The investment opportunities are almost endless.

To figure out if you are ‘investment ready’ we suggest you go through the following checklist which will give you an indication regarding your readiness to become a first-time investor!

• Before you consider investing, be sure to have 12 months’ worth of expenses put away in your emergency fund.
• Be free of credit card debt and have a working budget in place that allows you to save money each month.
• Only use risk capital for investments. Risk capital refers to money that you can afford to lose without putting you in dangerous financial circumstances.
• Have a team of trusted advisors or mentors at your disposal.
• Gain knowledge on the types of investments you are considering by conducting due diligence research.
• Determine the risk and potential reward. All investments have a certain amount of risk and reward. Ideally, you want to earn the highest return with the least amount of risk.
• Have an exit plan in place in case the investment doesn’t go as planned.

Action steps – Exercise 2 (5 minutes)

Go over the investment checklist. What do you think? Do you have any questions regarding any of the points? Let’s discuss it!

Lesson wrap-up

Today we discussed investments. What is it that you need to know before investing? What are some basic concepts and definitions? How does it work? We provided answers to all these questions. Moreover, we dug into the real estate market as a possible investment target and discussed the importance of diversifying when investing. The last thing we explored today was investment readiness by going through the investment checklist.

At this point we will wrap up today’s lesson. First, we will go over the learning objectives of this lesson and we want your feedback as to whether they have been achieved and then we will address any questions you may have. Please feel free to ask anything you’d like in relation to today’s lesson and we would love to hear how the concepts we discussed today relate to you and your life!