Must Know Terms
I need you to buckle up for this section. This is not going to be the most fun, but it's one of the most important things, and I like to think about this is the way lead into this chapter in the book. I have a very vivid memory of sitting in algebra class in eighth grade. I had no idea what was going on, and part of the reason I didn't know what was going on was because the language that was getting used and I remember my teacher said something about a coefficient and my mind just immediately goes blank. And I think I can't solve this problem because I have no idea what that means. Investing is pretty similar. Jargon gets used that as soon as you hear it, I feel like we just immediately check out and don't want to engage with it anymore. I also sidebar have a tinfoil hat conspiracy theory that they use overly complicated language to make us feel like we can't do this ourselves. And that's slightly been affirmed by people that I've spoken with as well. So we're going to go through diffe...
rent terms, gonna do the best I can to simplify them. But as we go, please feel free to raise your hand for further clarification in this section. First is diversification goes back to the cliche. Do not put all your eggs in one basket Pretty easy concept to understand. But what that means in terms of investing is making sure that you don't invest all of your money in just one company or one type of company, which gets referred to US sectors. So I'm actually going to give you re a life examples. This is not me endorsing individual stock picking. This is also not be endorsing these companies. I just think it provides better context for you if I say names that you're going to know. So we're recording this in Seattle. Who's here, guys? What's one of your big companies that's here? Yes. So let's say that I go out today after this class wraps and I go by 10 shares of Amazon. I am then invested in one company in one sector. That sector is tech technology. So tomorrow I'm like, you know what? I gotta diversify a little bit. I'm gonna go by 10 shares of Apple. Apparently I'm loaded. So now I've bought Amazon and Apple. I'm a little bit diversified because at least it's two different companies. But both of those companies are in the tech sector. So on Day three, I go out and buy Ford. Well, at least four gets me in a completely different sector of the stock market. Now we're talking more about transportation. So when you think about diversification in terms of investing, you want to make sure that it's multiple companies who do a lot of different things. There's a really easy way to do that, and that's looking at index funds, mutual funds and E. T. F. So those air types of investments that immediately get you diversified, whose you're investing in a lot of different companies across a variety of sectors where sometimes the same sector. But at least it's a bunch of different companies. Time horizon again With this, like overly fancy jargon, Time horizon is just a fancy way of someone saying to you, When do you want to use your money? I think a great example for us is retirement, So if you are 30 and you know you want to retire at 65 years as a time horizon on the money that you have in your retirement account. The reason it's so critical to understand time horizon is because that is going to inform how much risk you are willing to take with your investments. Because if you're on a short time horizon, you mentioned earlier wanting to buy a car in five years, and I was like, Maybe we don't invest that money because if that's a hard deadline and let's say you've invested it and in year four we go through a recession. Well, now you've just lost a lot of money and you don't necessarily have the timeto wait for it to come back around. Risk tolerance, that gut reaction that we feel that the idea of losing money I'm gonna be honest. Most of us don't have a warm and fuzzy feeling at the idea of losing money, but some of us can tolerate it better than others. Usually, people with a lot of money already been tolerated better than others. But I would say one thing that's really important to understand about risk tolerance, as you might have to fight against your natural instinct because I'll be honest with you In my real life, I'm pretty risk averse. I was like that goody goody two shoe kid in school. Never got a demerit. Never had a tardy like I was that kid. So you would think that in my investing life that it kind of translate to don't want take a lot of risk. I'm just gonna look at really conservative investments, but because of and we'll get to it a little bit later what I learned about how the stock market works that made me feel empowered and emboldened to actually put more risk on my money, but making sure that it was in alignment with my time horizon and when I needed access to that money. But I also understand that if you are naturally have a pretty high risk tolerance, you also don't want that to correlate to putting too much risk on your money. There does need to be a balance here, and some of that balance comes from asset allocation. But in order to explain that we first have to know about asset class, I like to describe it using beer because an asset class is just a grouping of similar investments. So if you think about it. An I p A. Lager ale stout. That's all beer but different kinds of beer. So it's similar things that are all in the same asset class. It's a grouping of similar investments when we talk about asset classes when it comes to investing, often times you're going to hear things like equities, a K, stocks, bonds, cash, cash equivalents and real estate those the major asset classes. Sometimes you're going to hear about things that are rather untested, more speculative asset classes, crypto currency and cannabis being two of the biggies like it talked about right now. But we're talking right now about sort of the tried and true. These guys have been vetted over long periods of time asset classes. So asset allocation is how much money of your overall investment portfolio you put into these individual asset classes. For example, let's say that you're thinking about retirement. You're thinking about it being about 30 years away. You're willing to put some risk on your money. You're gonna put 70% of it in stocks in 30% of it in bonds. This is not me giving you prescriptive investing advice. This is just an example, I'm gonna have to keep saying that, guys. So a 70 30 split really kind of correlates to you're willing to take a little bit more risk. You're being a little bit more aggressive, and that's what gets referred to as asset allocation. Now re balancing is what happens when your asset allocation gets a little bit out of whack. And there's a couple different ways that this could happen. But one of the big ones is if the markets doing well. So let's say, in 2019 the market does well. You were at a 30 split. Your stocks just went on a tear. And now, because of how well your stocks performed, you have gone to an 80 20 split. But you know, based on how you feel about your investments based on when you need access to this money, you needed to stay at 30. So what you're gonna have to dio is so off 10% of your stocks to buy more bonds so it goes back to that 70 30 split. That's a very simple way to explain re balancing anybody of any clarifying questions yet because please feel free to ask, How do you does it automatically, like switch to an 80 20 split? Or do you make it that way? I don't know. How do you keep track of that? So you're the what? So depends. If you are using a financial adviser or even a robo advisor, sometimes they do that for you automatically. That's part of the value that they're providing in the service. But usually you are the one. If your do it yourself investor that has to go in and take a look at how your portfolio is performing. And so you have to be able to look at the overall picture and see like, Oh, my stocks have done really well. So the value of my stocks compared to the value of my bonds right now has me at an 80 20 split. Then you have to sell in re. By how much do you have to invest to start your savings for the future? What that kind of money do you invest with? How much? That's a great question and something we're actually going to clarify a little bit better later because honestly, and this is an infuriating answer. It depends, So it depends on the stage that you're in. It also depends on the style of investing you're going for. So if you're gonna use a robo advisor or do it yourself or a full service brokerage or a micro investing app, all things we're going to talk about, don't worry if I've lost you, but those all costs different amounts of money. So the answer is it depends but will clarify that later. So a brokerage is a term you're gonna hear a lot. And I remember actually, it was really funny to me when I was first trying to source questions to go ask my experts. One of the things that I said was, Hey, what are terms? Especially people who are experienced investors were terms that were, you remember stressing you out and one of my friends that I didn't understand what a brokerage was for a really long time. You just hear that term over and over and over, and I didn't know what it meant. I kind of like to define it as the middle man because you and I aren't going to be calling up the New York Stock Exchange of the NASDAQ and saying, I want 10 shares of X. We have to go to an in between person to facilitate that for us, and that is a broker is the person or a brokerage is the company that you go to and they're going to be buying and selling on your behalf, and in exchange, you're gonna pay them some money to do it. So again, not endorsing. But I think it helps to contextualize, and you're gonna probably recognize some of these names. So examples of brokerages would include Fidelity, Vanguard, Charles Schwab, TD Ameritrade, Edward Jones, Scott Trade Ally, Invest and E Trade. That's not all of them, but that some of them and I think a lot of those air names that we've probably heard before. So when I say brokerage, those are the players that I am referring Teoh and their counterparts. It's really important to understand that not all brokerages or advisers have been created equal. I like to kind of compare it to hotels. Hotels, in essence, all do the same thing. They're providing a place for us to stay and maybe giving us a meal. But there are many different types of hotels that offer very different amenities, and that's kind of what you can think about with this. The more you pay, the more kind of White Glove first full service experience you're gonna have now that doesn't necessarily mean that it's better. It's just different. And it could be better for you, depending on what you need out of a brokerage. And I will continue to further clarify and refine your different options as we talk about how to actually put money into the stock market later on equities, stocks and shares. I want to keep reiterating this idea. As we go through these terms, you do not need to totally understand all of these things mean right now in this moment for those who are sitting in this classroom with me, especially, you don't have the advantage of pressing pause on me and rewinding and listening to it again. For those of you at home, please feel free to press, pause and rewind when you're watching this, because it does sometimes take time to really have the sink in and make sense. This is an example of where I'm going to try to break down the technicalities of what makes these different, but it doesn't really matter, but I'm going to try to do it anyway. So if this doesn't make sense to you, please do not stress about it. Equities, stocks and shares pretty much get used interchangeably when we talk about the stock market, but equities and stocks, you can kind of just say those are synonyms, stocks and shares slightly different meanings. Shares are technically what your stocks are broken into, so a very simple cliche way to explain it. If you have a pizza that your stock, the slices of pizza, those air your shares, it's all still pizza. But shares are what your stocks are broken into. So to further refine it, if you say to me I own stocks, I take that to mean that you own stocks and multiple companies. But if you say to me I own shares, my natural response could be, Oh, what company do you own shares off? Don't worry if this is like because it's not super important, just know that these get used interchangeably. But technically there are some small differences sectors returning to what we talked about in diversification sectors represent different industries of the stock market, so you want to make sure that you're diversified, that not everything is all in one sector when you're investing, common sectors would be health care, energy, tech, real estate, utilities, bonds I feel like we are all familiar with because we have been on the receiving are the wrong end of debt bonds or when you get to own a piece of a corporation or a government entity. So your Sallie Mae in this situation, what's going to happen is that bonds are considered a less risky investment because you're essentially owning debt and you assume that the person that owes you money is going to pay you back. So when we talk about maybe moving your portfolio to something that's a little bit less risky, more conservative, often times people are talking about moving your money into bonds or cash cash equivalents. But if you're still investing, technically, bonds are the more conservative option. Now there's an agreed upon interest rate. Why we don't call it interest rate. I don't know, because when we're talking about bonds, we say coupon or yield again, with further complicating things for seemingly unknown reasons. I'm sure there is a reason, but it just feels silly. So if you are a bondholder, so you've purchased a piece of debt from a company or a company or a government, then you're going to get paid out this coupon or yield, usually once or twice a year. It can change depending on the type of bond you have, but you're gonna be getting paid interest. And then the bond is going to do what's called reaching maturity. And that's the point that they owe you back the full amount that you loan to them. So over the course of the years, you're gonna be getting paid interest, and then eventually they pay you the full lump sum back. That's how a bond works, typically referred to as a less risky investment. We're gonna try to get into the differences between mutual funds, index funds and exchange traded funds. But what's really important to understand about all of these is it's a very simple way for you to be investing in a diversified portfolio because thes they're going to be investing you in a bunch of different companies, often across different sectors. At the same time. Let's break down how this works. It sounds really shady because you're essentially pooling your money with total strangers in order to get access to investments. Sounds really fun. One of the ways that this actually recently got broken down for me that I loved it was by a friend of mine, Kevin L. Matthews, who was referenced in my first book, and he talks about it like being in a neighborhood. You own one house when you own a stock, just own one house in the neighborhood. But when you have a mutual fund, an index fund, you own the whole neighborhood. I think that's a really nice way to put it, because it really gets you a lot more exposure and a lot more access when you want a mutual fund. Now there's a big difference between a mutual fund and an index fund. Here's the confusing part. An index fund is technically a type of mutual fund, but a traditional mutual fund is what we call actively managed. That means a really human is going in and deciding exactly what investments are being held in that mutual fund. So maybe there's the S and P 500 Index fund, which has 500 companies and their like I'm gonna pick what? I think you're gonna be the top 80 and that's what's going to be in this mutual fund now, in exchange for trusting a human to be able to pick what's going to perform the best, you pay a little bit more in the FiI that's called actively managed. A human is actively going in and making the decision process for you. Now with index funds, it's different. It's called passively managed. So instead of having a real person in there tinkering around, what it's doing is mirroring a portion of the stock market. So we call those an index. You might have heard the term Dow Jones S and P 500 Russell 3000. Those are all examples of a different index, which is a statistically significant portion of the stock market. Super fun to say so the Dow Jones is one of the oldest indexes that exist. Obviously, companies have changed over time, but those are a collection of what we would consider, like the heavy hitters that get represented in the stock market and the S and P 500 think like Fortune 500 companies. Those are the kind of guys that's going to be in there. So with an index fund, instead of having a human go in and pick, the companies were just going to say thes 500 companies. We want a slice of all of these pies, and we're just going to include that in our index that's known as passively managed A humans not making the decision and because it's passively managed, it's a little bit cheaper. Then you have exchange traded funds, also known as E T F. So I like to kind of consider these the hybrid between buying and selling stocks and owning funds. Because it is a fund, it is like a mutual fund or an index fund, and that it's gets you immediately diversified. You're buying into a lot of different companies, but you can actually buy and sell during trading hours of the stock market, where with index funds and mutual funds, if you decide Hey, I want to buy 500 more dollars of my S and P 500 index fund. Technically, that trade gets placed at the end of the day, but if you want to do it in real time, that's what any TF does again. If there's confusion happening here. It's not a huge deal. Just understand. Right now, it's okay to go back and re listen and also read up in other ways. The book explains it in much more context. But just understand that E. T s mutual funds and index funds all are giving you diversification in a way that buying and selling individual stocks does not. A lot of times, especially when you look at something like a micro investing app or even maybe a target date fund, you're going to be hearing things like aggressive, moderate and conservative portfolios. These are just ways of explaining Okay, if you're an aggressive portfolio, you're mostly invested in stocks, maybe 100% invested in stocks or maybe 10% in bonds. But mostly you're taking high amount of risk. You have a high risk tolerance. Hopefully, your time horizon is like 10 plus years away because you're putting more risk on your money. Then, as you get closer to your goal, you're going to switch to a little more moderate. So you got an even split, really between stocks and bonds and then as it's just around the corner that you want to achieve your goal. We're gonna move more conservative. A really important way to think about this is with retirement. Because when we're young, we can afford to take more risk. We got time. So if the market doesn't perform so well for a little bit and we see our portfolio go down, we got 20 years for this bad boy to come back around. We're fine, But maybe when we get about 15 years out or so from retirement, we don't wanna put so much risk on it. We're gonna move to a little bit more moderate of a portfolio a little bit more, even split. And then let's say we're about five years out from retirement and we're like, This is a hard deadline. I know I want to tire. At this age, I no longer want to put a lot of risk on my money. We're going to go more conservative, so it's more bonds and even cash with maybe a little bit invested in stocks. So that's where risk tolerance, time horizon and the way you're investing in your asset allocation. All kind of converges with this idea of aggressive, moderate and conservative portfolios and you'll hear these terms a lot, too, especially if use a robo advisor micro investing APS dividend. We all like getting paid. And when you hear about passive income, this is one of the things that people can be referring Teoh. Because when you own stocks, sometimes not all stocks but some stocks will pay you dividends. Which means sometimes it's every quarter. It's like every three months you get a nice piece of the pie of what that company has earned it. Kids automatically either in cash or you can do. It's known as a drip, which is a dividend reinvestment plan so automatically reinvest in tow. Whatever, let's say, mutual fund er index fund or E. T. F you're using. The reason the drip is a great thing to use is you're essentially getting investments at a discount because often times they do not charge you fees or commission to be reinvesting your dividend. So you get to save a little bit more money