I talk a lot with my friends about investing, entrepreneurship and personal growth. These topics are the core of my blog and are also the 3 main topics that I love to explore every day and learn more about it. Last week, I was talking with a friend about my new blog and she seemed interested. I was talking about which ETF is best when you don't want to follow the market every day and how I'm trying to understand the impact of the trade war on my portfolio when I realized something. I read about investing every day, it's my hobby and I love learning about a new way to invest or a new asset that could be added to my portfolio. But, not everyone likes that and sometimes when I write a post on my blog or speak with people, I don't realize that they may not understand every acronym or even every word I use. Therefore, I told her that I would create some posts on the basis of investing and try to clarify the technical language of the finance world.
First advice
Every time someone asks me for some help with their finance, the first thing I told them is: Are you diversified? Well, that's not true, the first thing I said is always that I'm not a financial advisor but normally I get a smile and we continue our conversation about the diversification of their portfolio. Investopedia, a really good website for anyone that wants to learn about finance, classifies all investments into 3 big categories: Ownership Investments, Lending Investments and Cash Equivalents.
Ownership Investments
Every investment that gives you a part of an asset is an ownership investment. If you buy a stock, you own a part of the company. If you buy a house and rent it well, you own the house. If you have a private share of a company, you own a part of that company. If you buy an ETF, you own a share of a portfolio that own a part of a company. If you buy gold as an investment, you own that gold and can sell it at any time. It is that simple.
Lending Investments
You should see these investments as if you were the bank. When you lend money to someone, you act like a bank. You probably don't realize it but you are probably already lending some money. If you have a savings account, you are lending money to the bank in exchange for a small return on investment. You can also buy bonds. A bond is a loan that you normally provide to a company or to the government that has a defined period of time and a fixed return on investment.
Cash Equivalents
Money market funds are investments that are designed to earn interest for the owner of the fund. The goal is to always keep the value of the investment and to give interest to the owner. The particularity of this investment is that you can easily access your funds. We call that a liquid investment. Don't forget that cash is also an investment. You don't have any risk but you also have zero gain.
Why is diversification crucial?
What are the differences between all these investments? There are 3 main characteristics of an investment: the return on investment (ROI), the liquidity and the risk level. Every investment has its own ROI, liquidity, and risk. This is why you need to diversify your portfolio. Let me explain that. If for example, you only have a non-liquid asset, what are you going to do if you have an emergency and need liquidity quickly? A high-risk asset can give you really good ROI but it can also bring you negative ROI. If you buy a stock that is super risky and the company declares bankruptcy, you would lose your investment. And finally, if you only buy non-risk, high liquidity asset, there is a good chance you will also have a really low ROI. Keep in mind that the average inflation since 1913 is around 3% per year. This means that if your investment earns less than 3% per year, you are technically losing money. You are losing buying power. So to all of my friends that put all their money in a savings account at the bank, you are losing buying power.
Here is how I see the liquidity, ROI, and risk of all my investments:
(The higher the better)
* Stock Options are normally only available for an employee of a private company or accredited investors.
** I use the app Robinhood to buy and sell stocks and ETF without a fee.
*** I use Fundrise to buy Real Estate Stock
As you can see the higher the ROI is, the more the Risk is. This is why you need to diversify. You need to judge your tolerance to the risk and create your portfolio in consequence.
For my personal portfolio, I'm fine with a high level of risk. The reason for that is that I'm still young and that I have a good day job that provides a good income. This gives me the opportunity to be a little bit aggressive.
Here is the distribution of my portfolio investment:
