PART II – WHAT & WHY OF EACH STEP
In this part, I will elaborate on each step and its importance. This list is not an exhaustive one but I think covers the most important. In the next part (III) I will explain the ‘how’ of each step. To review Part I click here.
– Its a necessary beginning for all investors. If you can’t get your personal finances in order, you will not be a good investor.
– Personal finances plays a very large part of investing, as it requires many of the same skills. It includes budgeting, self-control, discipline, money allocation, prioritizing, differentiating between essential & non-essential expenses, risk assessment, dealing with financial hardships, short & long term planning.
– For stocks, business ventures/partnerships, you need to determine if they (company, partners) are adequately keeping finances in check. How can you determine if someone else is able to, if you aren’t even able to do it yourself?
– How can you invest if you don’t have money? Personal finance helps you save, allocate, or think of ways to generate money that can be used for investing.
Update 6/1/2009: See Personal Finance, The Essential First Step To Investing, to learn why it is such an important step before learning to invest.
Educate Yourself On Subject Area, Increase Your Knowledge Continually (DIY):
– Terminology – Do you know what capital gains are to an investor? Free Cash Flow for a company? Net interest margin for a bank? Easement in real estate? Return On Equity? Net asset value?
– General investing – concepts, principles, steps, different types of investments, etc.
– Subject area – You need general knowledge of the specific investment vehicle (stocks, bonds, real estate, other). This is where you learn advantages, disadvantages, law, tax, techniques, analysis, and principles related to the specific vehicle. Then you also need to gain specific knowledge of the subject area related to the investment itself. For example, if investing in commercial real estate, you need to learn about investing in real estate in general, then learn about commercial real estate (warehouses, retail fronts, offices, law, tax, local government, etc). For stocks, you need to learn about stocks in general, then the business area the specific company operates in. If you don’t have enough knowledge, then you cannot determine how to make money from the investment, assess the true risks involved, or compare the quality of the investment.
– Knowledge – It is not a single piece of information, but a collection. You have to keep adding pieces in order to grow the collection. Knowledge & information is essential to making good investment decisions, & avoiding bad ones.
Educate Yourself On The Economy & General Economic Trends (FA):
– Educate yourself on the economy and general economic trends. This is the bare minimum if you decide to rely on an FA. This helps facilitate communication of investment ideas and general opportunities with your FA.
– You have to keep up with general economic knowledge so that you can ask intelligent questions to the FA, or be able to determine if they are providing the type of advice you need. It will also help them work with you to find investments that are suitable for you and fits your goals.
Make Sure You Have the Right Attitude & Mindset (DIY):
– If you want to become wealthy, DIY is the method that will get you there. Attitude & mindset is usually the make or break of a successful investor. This is because one’s attitude will determine if the individual will actually be able to achieve the points listed above or not. Everything else flows from it:
– Discipline & self-control, patience, attitude for learning & knowledge.
– Keeping things logical and not emotional (greed/fear are worst enemy). Make sure you can stomach the characteristics of the investment (volatility of the stock market, large debts of real estate, etc). Would you be able to purchase a US bank stock if all your research & risk assessment told you its a good low risk investment? Even though it has already lost 42% of its market value and is continuing the slide? .
– Accepting & learning from mistakes. They happen, and you learn the most from them.
– Getting rid of your ego, and keeping an open mind. Listen to different perspectives. Analyze, integrate or discard new information carefully. Don’t let ego & past success get in your way of improving. Keeping an open mind is required in order to learn and accept new ideas/concepts. It is also necessary in order to break free from years of institutionalized programming, that has defined for the general population what investing is and how they are supposed to invest.
– Don’t believe everything you hear. Media these days say anything at anytime, without taking any responsibility for it. Filter out the facts from fiction. Always assess the credibility of the information you hear.
– Contrarian view – Going against the herd when necessary (more often than not). This coincides with confidence & peer pressure. 90% of the world has no clue what they are really doing, so need to be able to trust your own data & analysis, and make your own decisions even if its not a popular choice.
– I would like to also note that the attitude & mindset of an investor is usually not the same as what is taught in school or by most parents. Its an attitude that the general population (the working middle class) does not have. School and most parents, teach kids to go to school and get a good education, so that they can get a good job, with a steady paycheque, at a good company, then retire after about 40 years of working and investing in RSPs/401ks by buying into mutual funds. The media doesn’t help much either. The media brainwashes the population to strive for working at a prestigious company, climb the corporate ladder, devote all your time and effort to the company, and leave the investing of your mutual funds to someone at the bank.
– I’ve come to realize that DIY investing really isn’t for everyone. The choice, ultimately resides with each individual. Some are too plugged into the working middle class mentality and cannot be pulled out. Also, they may not want to be pulled out either. Essentially, the years have solidified them into the collective working middle class paradigm. I can go on about this in much more detail, but that is best saved for another article.
Know How To Find A Competent, Knowledgeable, Honest Advisor (FA):
– Good help is really hard to find these days, especially when it comes to the area of investing and finances. You will want a FA who is knowledgeable and competent in his area of specialty.
– Not all advisors have the right knowledge, in fact many don’t which is why so many people have lost their life savings in the market from bad advice. There is only so many times you can lose such large amounts of money before you are old. Many people in their 40-50s have lost it twice already in the last decade alone.
– An advisor, in any knowledge domain, should be competent and fill gaps of knowledge that you need to have filled. You are ultimately the decision maker, their role is to help you make the right decision based on their knowledge expertise. The wrong advisor can lead you down a dangerous path.
– A competent advisor will be able to serve your needs using a variety of investment vehicles. They would be able to steer you away from certain investments if they feel they are unsuitable for you, even if you were interested in them. They should be able to explain their reasoning, and would not afraid to tell you to hold cash until the opportunities arise.
– Honesty in a FA is a must. They shouldn’t be afraid to tell you how they are paid. Many also receive commission for selling mutual funds etc. Your FA (if from a bank) should not be hesitant to suggest financial instruments from other institutions or suggest selling off ones from their own bank if it is in your best interests.
Know Yourself, Your Needs, Your Goals
DIY – (gives you direction – learning, control, etc)
– Know your strengths & weaknesses. Use your strengths & strengthen your weaknesses.
– Know your limitations – At different points in time there will be different limitations which may prevent you from investing in certain investments. These limitations may be caused by a variety of reasons (financial, personal, political, timing, knowledge, situational, etc). By being aware and recognizing the limitation(s), you can then determine how & when the limitation(s) can be overcome, if even possible at all.
– Know your circle of competence – You can’t know everything. Know where your knowledge competency ends. Most have a certain level of domain knowledge in one area and hence have a certain level of expertise. However, they also believe they have the same level of expertise in a totally different domain without actually having the same level of domain knowledge. In the new domain, they are not able to make knowledgeable decisions. They make incorrect analysis & assessments of risk. This usually leads to bad investment choices, and financial loss. If you are able to determine that are not competent enough in a certain area, then you are also able to determine if you can increase your competency or work within it.
– Know your needs & goals – This gives you ultimate direction, and something you can create a plan based on. If you don’t know where you are going, you most certainly won’t get there. Goals also help give you something to track your progress to. This also helps determine whether you want to take the DIY path (the only path for certain goals) or not.
– Short term goals may be to attain certain knowledge necessary to get to the next step of investing in a certain investment vehicle. It may also be saving a specific amount to invest in a real estate partnership. Etc.
– Longer term goals can be to become financially free by 40 years old. It can also be attaining $1M within x years.
– Never lose sight of your goals.
FA – (So the advisor can best assist you)
– The above may still apply but more for the purpose of knowing how the FA can best assist you, and enabling them to do so. If you don’t know your limitations, situation, finances, and goals, your FA won’t either.
Build Your Advisory Team:
– Accountant, FA, Real Estate Agent(s), Lawyer(s), management team, etc.
– Whatever area you decide to invest in you will only have a specified amount of knowledge at a particular point in time. You won’t know everything, and you need someone who knows what you don’t.
– Your advisors will know the fine details of different investment aspects or processes.
For example your accountant will know the details of assessing the tax implications of an investment. Your real estate agent will know the fine details of the purchasing process for property.
– You may have several advisors of the same type, but of different specialization.
For example, lawyers who deal mainly with litigation, or real estate. Real estate agents specializing in residential or commercial real estate.
– You may outgrow your advisor one day. Because they are providing specialized services, they are very likely not going to grow their knowledge substantially outside their specialization.
In Part III, I will elaborate how to go about each step, and give some suggestions and recommendations.
Thanks & Happy Investing!
The Investment Blogger