Personal Finance & Investing 101
9 Jul 2019
- What is this?
- Why learn about personal finance?
- Why read this document specifically?
- Why did I write this?
- How to Read This?
- How to get Wealthy in one Picture
- If I Could Only Tell You 4 Things
- Defining Wealthy
- A Note on Saving
- Opportunity Cost
- Interest Rate (and why it’s important)
- Portfolio 1 - No Diversification
- Portfolio 2 - Some Diversification within Asset Class
- Portfolio 3 - Some Diversification across Asset Class
- Portfolio 4 - More Diversification across Multiple Asset Classes
- Portfolio 5 - Even More Diversification across Multiple Asset Classe
- Volatility & Risk
- “Priced in” and Beating the Market
- Exit (and why it’s important)
- Stock Ticker/Symbol
- Dollar Cost Averaging
- Investing my first £1,000
- Investing my first £5,000
- Investing my first £50,000
- Thesis investing
- Tech Stocks
- Tech Enterprise
- Digital Infrastructure
- Death of Retail
- 9 to 90
- Buy The Dips
- For further reading
- For timely information
- For managing your finances
For making your first investments
- Diversified Portfolio
- For tracking your Investments
- Should I always invest in big names?
- How many stocks to be diversified?
- Should I pay off my student loan?
What is this?
This document is a collection of ideas on the topic of personal finance and investing. It is a summary. It is a collection of resources, tools and services. I formed this document after reading many books on the topic as well as personal experience investing over the last 4 years.
This document is not financial advice. I am not a financial adviser. This is just a summary of what I’ve read and experienced.
Why learn about personal finance?
Because it’s so important! Over the course of a lifetime, better financial management can make a huge difference to your wealth (and standard of life). For some reason, we are not taught this in school, which means it’s our responsibility to teach ourselves.
Why read this document specifically?
Read this because its is quicker than reading 10+ investment books yourself. Read this if you want a high-level overview of the important ideas in personal finance and investing. Read this if you want to see some actual resources and tools that can help you start investing today.
Why did I write this?
Because my friends asked me to. They knew I took an interest in the topic and had read widely on it. They asked me if I could summarize it for them. This document is my attempt to do that.
How to Read This?
I’ve tried to organise it in a way that will be easy to read from beginning to end. However, depending on your needs and interests, some segments may be of more interest than others, so I have written them in a way that should make sense as standalone chunks.
Use the contents page and document outline (view > show document outline) to navigate through this easily.
TLDR: Too Long, Didn’t Read
How to get Wealthy in one Picture
If I Could Only Tell You 4 Things
- Start investing early. The earlier you start, the more your investments benefit from compounding (see section on compounding for full details). Starting early increases your chances of getting wealthy.
- Learn to manage your spending. No matter how much you earn, you need to be capable of spending less, in order to become wealthy. Building healthy spending habits increases your chances of getting wealthy.
- For most people, a diversified approach is best. Essentially, this means don’t put all your eggs in one basket. When you don’t diversify, you run the risk that one bad investment can severely impact your net worth. Luckily, diversification is really easy to do with modern services (see section on Tools and Services). Diversification increases your chances of getting wealthy, with less risk.
But first, invest in yourself. If you’re struggling to save/invest enough money because your salary isn’t high enough, focus on that first. Invest in education, qualifications, learning, re-training, getting a promotion, negotiation a higher salary etc. A higher salary increases your chances of getting wealthy.
- A colloquial definition of wealthy - having money, being rich, affluent.
- A financial definition of wealthy - having more assets (investments that earn a yield) than liabilities (costs). The chief concern is owning investments that grow in value over time.
- A broader definition of wealthy - having enough money that your can do what you want, when you want.
In general, this document is focused on the second definition of wealthy. The ideas center on buying and investing in assets that will earn a yield/interest over time and grow in value. But it is written with the third definition in mind and as the goal.
A Note on Saving
Saving is important. It is a good idea to keep some savings at all times - mostly in case of emergencies (you lose your job, your house gets hit by a tornado, etc). This is particularly important if you also have financial dependents (children, grandparent, etc).
For your savings, find a high-interest savings account (see interest rate section for more details). Also, think about how you may need to access your savings. If you want to be able to take money out instantly, you’ll need an instant access account. Otherwise some savings accounts can lock away your money for 6 months, 12 months, etc.
But savings do not grow (meaningfully) in value over time. This will be the only section on saving. The rest of this document will focus on investing.
Useful Economics Concepts
One of the biggest principles in economics is opportunity cost. It is also useful in the context of investing.
In a world with limited resources, opportunity cost is when we choose something, we forgo another alternative. In personal finance, it refers to how we choose to spend our money. For example, the opportunity cost of a 50p can of coke is a 50p snickers bar.
It can be used for any resource though, for example time; the opportunity cost of watching a football game is watching 3 episodes of Friends.
In investing, we come across opportunity cost all the time, so it is important to be aware of. For example, when choosing what areas to invest in we encounter opportunity cost. The opportunity cost of investing £50k in property is buying £50k worth of stocks.
We also encounter it when making decisions not to invest. For example, investing all of our money now, implies the opportunity cost that we can’t invest it all tomorrow (when perhaps a more interesting investment opportunity becomes available).
In general, you should think about opportunity cost of allocating your money. Remember, you are not just trying to make a good investment decision, but rather, you’re trying to make the best investment decision of a (almost) infinite amount of alternatives. Opportunity cost reminds us that for every £ invested we are forgoing investment opportunities elsewhere.
Interest Rate (and why it’s important)
The interest rate is set by the government and denotes an increase in value of our savings. The interest rate is meant to offset inflation (where inflation is the general increase in prices year or year). If we have £100k in a savings account, and the interest rate is 1%, our savings will gain interest of £1k each month.
The interest rate is important as it is the lower limit of how much our wealth will increase if you don’t invest - no investment, no ISA, no stocks or property. Therefore this is the minimum we are trying to ‘beat’ in order to increase our wealth. If we can make an investment that will earn a 5% yield, or a 10% yield or a 50% yield we would be more than beating the interest rate, which in turn would warrant the effort of doing it.
In summary, remember - when you invest, you should ask yourself ‘does this have the potential to beat the interest rate?’.
- In the last 5 years the inflation rate has been very low, so saving via the bank has been quite an unattractive option.
- Some current accounts don’t even give you interest. This means your money, left in a current account, is actually depreciating in value over time.
Compounding is an absolutely crucial law of investing. Compounding is the process in which an asset’s earnings, from either capital gains (increases in value) or interest, are reinvested to generate additional earnings over time.
The way to think of this - over time, your investments make more money at an increasing rate.
Perhaps the easiest way to understand it is visually:
Compounding has a few important implications for investing: You can only benefit form compounding if you keep your interest/yield/returns within the portfolio. Every time you remove money from your investments, you are reducing the power of its compounding. (This doesn’t mean don’t do it - sometimes you need access to your money - but it does mean you should do this in an informed and thoughtful way).
The earlier you start investing, the better. This is because your investments have more time to benefit from compounding. See the visual example below.
This is simply the term used for a collection of investments. If you had invested in multiple stocks, a crypto currency and an ISA you could describe this as your portfolio of investments.
Is one of the most important ideas in investing. Diversification occurs when a portfolio has a mixture of investments (or assets); often with varying associated risks and different fundamentals. The idea here is that my having a mixture of investments, you protect yourself from the risk that your portfolio can be severely impacted by one bad investment. An expression here might be “don’t put all your eggs in one basket”.
Let’s take an example where you have 50k to invest.
ISA = Low Risk Property = Low/Medium Risk Stocks & Shares = Medium Risk Cryptocurrencies = High Risk (Risk levels are rough and mostly for arguments sake)
Portfolio 1 - No Diversification E.g. £50k all in Amazon Stock —> Not diversified. If Amazon was to suffer a decrease in value your whole portfolio tanks.
Portfolio 2 - Some Diversification within Asset Class E.g. £25k in Amazon Stock and £25k in Google Stock —> Slightly more diversified. If Amazon suffers a decrease in value, only half your portfolio is impacted. In fact, Google may increase, which could offset the downside. You could argue that Amazon & Google are similar businesses, so perhaps they are subject to similar downturns…
Portfolio 3 - Some Diversification across Asset Class E.g. £20k in Amazon Stock, £20k in Google Stock and £10k in Cryptocurrency —> More diversification. We have introduced another asset class which adds diversity. But note this asset class (Crypto) is also riskier, so the overall risk of the portfolio has increased…
Portfolio 4 - More Diversification across Multiple Asset Classes £10k in Amazon Stock, £10k in Google Stock, £10k in Cryptocurrency and £20k in property —> Even more diversified. We have now introduced property, adding another asset class. Property is also lower risk and generally more stable, meaning the overall risk of the portfolio has decreased.
Portfolio 5 - Even More Diversification across Multiple Asset Classes £5k in Amazon Stock, £5k in Google Stock, £10k in Cryptocurrency, £15k in property and £15k ISA —> More diversified. Here we have also added an ISA, which is a pretty risk free investment (although can lock up your cash).
The above portfolio’s move roughly from least diversified (1) to most diversified (5). I have tried to demonstrate that this is not a definite science though (although many professional investors will try to apply maths & statistics to make it so). You could argue that portfolio’s have more or less risk / more or less diversity on a number of grounds. The general rule however is that it is probably wise to not invest all your money in one asset class.
It’s important to not diversification also has a downside. By diversifying and managing risk, you are to some extent also limiting your upside. For example, if you invested all your money in Amazon 10 years ago, you would be extremely wealthy. The trouble is, it’s hard to predict exactly which investment will be best, so diversification is a way to cover more bases.
Related - Another important thing to remember here is the Warren Buffet Philosophy - invest in areas you know and understand. If diversification requires that you need to invest in areas you are unfamiliar with, this may be a negative strategy rather than positive. For example, if you know nothing about Cryptocurrency and do not want to learn about it, you probably shouldn’t invest lots of money in it.
Volatility & Risk
Volatility describes how quickly an asset moves up and down in price. If it moves up and down quickly and frequently, it is highly volatile (e.g. Crypto). If it is fairly steady over time, for example house prices, it is seen as less volatile. Newer asset classes, or asset classes where the fundamentals are lesser known and harder to understand are often more volatile. Asset classes which are old, well known and well understood are often less volatile.
Related to volatility is risk. Riskier assets are those which are generally susceptible to larger price swings. This is often because the fundamentals can be changing quickly or lesser known. An investors appetite for risk is very important as it informs her investment decisions. Risk is often linked to reward; in order to win big, you need to have some appetite for risk.
Fundamentals refer to the underlying factors that affect an asset. For example:
- Property: Transport links in the area, growth of economy, unemployment rate, culture towards housing, etc. Stocks and Shares (in general) —> Growth of economy, disposable income levels, etc.
- Amazon Ltd: Growth in digital retail, competition, revenue figures, user growth, profit margin, etc.
In general, it is difficult to understand all the fundamentals at play. However, an informed investor will have a good grasp of the fundamentals of the asset he is investing in and the economy as a whole. For example, if you believed that the internet was doomed to fail and that as a society we were going to ban all computers, you probably wouldn’t want to invest in Amazon Ltd shares. If however, you believed that the internet is just getting started and that the digital economy stands to grow even more, you would probably invest heavily in internet companies.
“Priced in” and Beating the Market
It’s important to understand that the price of an asset today, reflects to some extent the expected value of it tomorrow. This is to say that often growth (or value increase) is “priced in” to the value already. Let’s take a concrete example. If Amazon stock is valued at £1200, and investors believe it is growing well and likely to be more valuable than that next month, they begin to buy it now. As the demand for the stock increases now, the value of the stock increases now, pushing up its price. Therefore in a perfect market, the price of a stock or asset always considers the demand other investors place on it.
Which leads to an important implication. In order to “beat the market” an investor needs not to just pick a good stock, but also to pick a good stock that no one else thought was a good stock (or at least that not everyone knew was a good stock). Why? Because if everyone knew it was a good stock to invest in, they would have invested in it, the value of the stock would have increased, and the new value would have been “priced in” and therefore you wouldn’t make money on it. Investors will often say they ‘were early’ on a good stock if they managed to buy it before people in general realised it was doing well, thus they can beat the market.
In investing, liquidity refers to how quickly we can turn our investment back into cash. For example, stocks are quite liquid, as we can quickly sell them on the market and get the value back in cash. Property is less liquid, as there is no guarantee we can find a willing and able buyer right away. It is important to consider liquidity as you may have a number of reasons why you desire to turn your investments back into cash. One may be that you want to make a significant cash purchase, such as buy a family home. Another may be that you want to reinvest that money elsewhere e.g. sell £50k of stock and buy £50k of bitcoin. If an investment is not liquid you may not be able to do so easily, swiftly or at all. Note in the second case - where you are reinvesting - the reinvestment may be time dependent, so the speed of liquidity in important. In general, you can think of liquidity as a positive trait of an investment;the more liquid the better.
Exit (and why it’s important)
To “exit” an investment means to sell it. The exit is an important part of all investing as it is the moment that our investment actually returns to cash in our pocket. Up until that point, we just have a portfolio that is estimated to be worth some amount. Depending on the market, you may or may not be able to actually exit at the same value. For example, say I own a £1m house in London. But when it comes to selling it I can only get a bid of £950k. If I sell at this price my portfolio has essentially lost £5k in real value. Similarly for stocks, we might own £50k worth of $AMZN, but until we ‘exit’ and get that £50k in cash, it is only an approximation. Stock Ticker/Symbol You may have noticed I described Amazon PLC stock as $AMZN. This is known as its stock ticker or symbol. All publicly trading companies get one when they are listed on public markets.
Dollar Cost Averaging
This is a more technical point, but is useful if you’re planning to start putting bigger money into stocks. Dollar cost averaging is a strategy to buy stocks which says we should buy a stock in equal increments over time, rather than all at once. For example, if I wanted to hold a position in $AMZN I would buy $1k of Amazon every month for a year rather than $12k all at once. Why? The idea is to average out fluctuations in the price. If you bought all $12k at once, and the market happened to be high that day, it may be that you bought at an expensive time (bad scenario). It could work the other way, that you happened to buy at a cheap time when the market was low (good scenario). Dollar cost averaging - purchasing over time - takes this element of luck out of it. As you average your purchasing over a year, sometimes you may buy cheap, sometimes you may buy expensive, but the point is you’ve bought the position you want at a price trending toward the average. (Note - This is more relevant when you are investing significant amounts of money. It is also slightly dependant on the trading platform you use. If you are charged a transaction fee or commission every time you buy a stock it may be less relevant).
Practical Investing Strategies
I’ve tried to stay away from giving concrete advice. But I realise by doing so, this document may not be as practical and useful as it could be. So below I try to share some practical experience of what I would do with actual sums of money.
In the below scenarios I assume you have taken care of rent, food and any interest-yielding debt. If you haven’t take care of these points first! The below is for disposable money you can save or invest.
Investing my first £1,000
With this sum of money, the most important thing is to get into the market in a way that is easy and relatively risk-free. I would put all of it into a diversified portfolio (with someone like Nutmeg - see services section) or choose an Index or ETF that I liked via Freetrade (see services). This way I can begin to see the benefits of the market and get a taste for how it changes over time. You also benefit immediately from diversification (these services build diversification in). Importantly, the fees are also very small and the platforms are easy to manage, so you can benefit from compounding (see compounding section) in an easy way.
Investing my first £5,000
Now you have a little more money to play with I would do a variation of the above. I would still maintain 80% (£4,000) in a diversified portfolio. But with the remaining £1,000 I would explore another asset class that you have an interest in. For example, if you like the idea of picking stocks, try buying a few stocks (via Freetrade or Hargreaves Lansdown). If you have an interest in property try investing in a few projects via Property Partner or Lend Invest (as you won’t have enough money to invest directly in property). The benefit of this strategy is you maintain the benefits of diversification from the first investment (diversified portfolio), but you also begin to learn about another market and asset class. At this early stage of investing, the learning counts for a lot. You want to get a feel for what you like about the market and if its behavior (risk, volatility, etc) suits your personality.
Investing my first £50,000
Now you have considerably more options with your money. What you do here will largely depend on the experience you had above. If your diversified portfolio has continued to perform well, you may just pour more money into that - it’s easy to do and will benefit even more form compounding. If your second investment (in stocks or properties) is performing well, you may also want to dial that up. You may also want to consider other investments and asset classes. The point is to take your learnings from before and continue in a way that makes sense for you.
Strategies for Stock Investing
This section is only of interest for people who want to know about stock investing. Before I continue: This is not financial advice - if you buy a stock and lose money, it’s on you. There is no one way of buying stocks. The way I do it may not be the best way. In fact, there are many diff ‘types’ of investor who trade in very different ways.
Anyway, I’ll share with you some strategies that have been helpful for me.
This is a simple one. It means whatever stock you buy, hold it for a long time (say 5+ years). Why? Because the market generally trends up. So in general, the longer you hold a stock, the higher the chance it will increase in value.
This is when you develop a view, or ‘thesis’, about the way the world, markets and economy is developing and buy stocks based on that. It is typically a hold model (i.e. buy stocks with a view to holding them for several years, rather than selling quickly). They say that markets are good at pricing in the next 6 months, but less good at long term, so the idea here is if you have a strong belief about the way the world is going to develop, you can make money by investing in that and holding for a long time.
See below for a screenshot of my Hargreaves Lansdown watchlists (whatchlists are just a way you can track stocks), which is roughly organised by different thesis.
Quite simple, this thesis is that tech companies will me even more significant that people think. The internet will play a bigger role in all parts of the economy. I therefore invest in lots of tech companies. This watchlist includes companies like Amazon, Google, Facebook, Apple etc. (Note - That i said ‘than people think’. Again this is to do with the priced in nature of stocks. If everyone believed this, it would already be reflected in the stock prices. So importantly your thesis must be something that you believe that at least not everyone else does).
Similar to above, but specifically technology building tools for enterprise companies (large, multi corps). This includes companies like Workday and Zendesk.
This is the thesis that some of our infrastructure that is core to the economy is now purely tech, and provided by tech companies. For example, digital payments. Companies here include Visa, MasterCard, MongoDB, Twilio, Square, PayPal.
Death of Retail
This thesis suggests that retail stores/brick and mortar stores are dying and all shopping will transition to online. Stocks that benefit from this transition here include Amazon, EasyJet, RyanAir.
9 to 90
This thesis is that some brands are so powerful they are loved by people from 9 years old to 90 years old and will continue to grow regardless. Brands here include Apple, Starbucks, Dominoes, Nike.
Note - Some of the above is simply my ideas, or ideas I’ve borrowed from investors I admire. You don’t have to agree with them. But thesis investing for me is the most powerful kind as it taps into changes in the actual world, rather than simply price fluctuations.
Buy The Dips
Follow a bunch of stocks you like, and when you see one has suffered a price crash, you buy it. The idea here is that stocks can often suffer somewhat arbitrary price crashes because of some announcement or news that investors don’t like. Does this really mean that in one day a whole company is 10% less valuable? Perhaps, but also probably not. So in some ways when this happens you can get the stock ‘for cheap’.
An example of this, if you had been tracking Square Inc (an American payments company) for the last few years, you would have noticed in December 2017 it dropped over 20% in value. If you bought it then, you could consider yourself buying it on sale. In the 11 months after, it went on to double in value.
Note - This is related to thesis investing as you need to be following certain stocks anyway to see if they crash. It’s just a way for me to increase the urgency at which I buy them. If I can ‘get them cheap’ I will.
Resources, Tools & Services
I was just catching up on some emails and realised these would be useful for you.
For further reading
- I Will Teach You To Be Rich - Good primer on personal finance. Aimed at the absolute beginner. American context. Focus on diversified long-term investing. You can see my summary of this book here.
- The Simple Path to Wealth - Great book on long-term diversified investing strategy. Like I Will Teach You To Be Rich, but slightly more advanced.
- Rich Dad, Poor Dad - Great book on the mindset of an investor. Focus on principles. Entrepreneurial tilt. You can see my summary of this book here.
- Intelligent Investor - For people who want to know more about valuing companies and picking specific stocks. Seen as the bible of value investing. Very dense.
For timely information
Two regular newsletters that I absolutely recommend regarding investing:
- Finimize - Great for general economy highlights/lowlights and to stay on top of markets.
- Howard Lindzon Newsletter - An investor I follow closely, has some good advice in his emails (also humourous, but US centric).
- Seeking Alpha - Professional investors write their opinions on public companies. Useful to search a company and see if you’ve missed anything.
- The Stock Club (podcast) - Excellent podcast where a group of professional investors discuss trends, markets and stocks. Useful as they give actual stocks picks.
- Rule Breaker Investing (podcast) - Another excellent podcast with the team at The Motley Fool.
For managing your finances
- Money Dashboard - Built on top of open-banking, Money Dashboard allows your to aggregate all of your banks and credit cards into one dashboard. Useful to get an overall picture of your finances.
For making your first investments
I have used each of the below services personally (unless stated). I’ve added a brief explanation of my experience with them. Where possible, I have supplied a link that will use my account as a referral.
- Nutmeg - An easy way to get started with a diversified portfolio. Good interface, easy to use, good content. Performed well for me whilst I’ve had it.
- Wealthify - Similar to Nutmeg. Haven’t used personally.
- WealthSimple - Similar to Nutmeg. Haven’t used personally.
- MoneyBox - A cool app that rounds up your spending and funnels it into investments. Useful if you can’t build the habit of saving/investing.
- Freetrade - Easy and cost-effective way to buy many stocks. New player, so currently not all stocks available.
- Hargreaves Lansdown - Older player, so all stocks available. App and website are good. More expensive commision (£11.95 per trade).
- Property Partner - Buy shares in a house (as you would buy shares in a company). Pays interest/dividends on a monthly basis. I’ve found that its hard to get liquidity. I haven’t been able to sell my shares at the prices the company suggests.
- LendInvest - Easy to use. Good amount of deals coming onto the platforms. All of the projects I invested in where paid back in full and on time, with interest.
For tracking your Investments
Stocktwits - Useful to create Watchlists and listen to the chatter on your favourite stocks.
Should I always invest in big names? To be able to invest (buy stocks) in companies they have to be publicly listed, which by definition means they are ‘bigger’ companies. Having said that, would I only invest in big brand companies? Not necessarily. It completely depends on a) do you think there is an opportunity to make money? b) do you have good information about that company? In fact, there is probably a bigger opportunity to make money on lesser known companies as its less likely that people will have information about them, having said that, it’s also less likely you will too.
How many stocks to be diversified? This is mostly a case of preference and will also depend on how much money you have to invest. There is a balance between having enough stocks to be diversified and so many stocks that it becomes hard to manage. I think for modest amounts of money 6-12 stocks is reasonable.
Should I pay off my student loan? People frequently ask if they should pay off their student loan ahead of time. This is really a matter of taste. If you are uncomfortable having debt to your name for whatever reason, pay it off. But as debt goes, the interest on a loan is pretty low. If you could invest that £20k into a solid investment, earning 8% annually, you would actually make more on the yield than you would lose toward your interest on a loan.
Should I contribute to my work pension? If your employer makes contributions to your pension aswell, this is probably a great idea. Assuming your pension fund invests sensibly (you should be able to see their previous performance) it makes sense to contribute as much to your pension as needed to maximise your employers contribution. For example, if your employer contributes 5% toward your pensions based on your contributing 5%, I would certainly do that. Your pension savings receive some tax benefits which make them an attractive place to save.
Ask me anything
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