Investing 201: Laying the Foundation
By: Saad Fazil
Tags: Hedge Funds, Stocks, Investing, Venture Capital

This will be one of a series of posts where I will write about my thoughts about and experience with investing. I have never been a professional investor nor have any plans to do so¹, but find the topic of personal interest (and growing importance, as we will see). My objectives with this series are as follows:

- Share my somewhat limited learning in a concise format with my peers who may want to exchange notes

- Serve as an “educational” material for a novice to medium-level investor and those earlier (or in mid) in their careers². That said, there is tremendous amount of great material and classes on the internet, and my posts are informal and personal — exactly the way I want them to be — and not meant to be academic or necessarily accurate to the point, to the extent a certain level of accuracy can indeed hold true in the world of investment (investing is not a natural science after all). Much of what follows are my opinions, and can easily be challenged.

Each post will typically focus on a particular “bucket” of asset classes. The way I characterize these buckets and asset classes is what suits my needs and what I find helpful for my own research and planning. They may not perfectly fit with a stricter definition of an asset class(es). Moreover, while I consider each bucket separate, there are definite conceptual overlaps between them (which I will do my best to point to). But at least in my head, it is clear where a specific investment lies in my classification (which is not very far from most popular definitions).

Which path you follow will obviously depend a lot on how much money you have at your disposal, your short-term needs, your risk appetite, amongst other things. In addition, I assume, that you do not have enough money to tap into private banking, though even if you do, I hope you can learn a thing or two from my posts.

It may help (and also feel good) to think of yourself as a Chief Investment Officer — that is you cannot outsource everything to private banking, financial advisor, or a portfolio manager. This is sort of akin to the job of Chief Investment Officer of say a large endowment fund³, where she may outsource certain types of investing to respective experts (Hedge Funds, Private Equity, to name a few), but she still needs to decide how to allocate capital at the top level (of course, a CIO of an endowment fund is a full-time job, and one that “manages” billions of dollars if at one of the top tier schools — I just find the analogy interesting, despite a massive difference in terms of money being managed or the time required).

Before discussing each bucket in detail, let’s lay the foundation.

1) Your goal for investing may take different forms — from saving aside funds for education of your kids, to travel plans, to retirement. My primary goal is to build comfortable wealth and to be able to retire when I want; it does not mean I would want to retire. Moreover, I enjoy investing as a “hobby”, while making decent money (I hope).

I like the well known 4% rule. Very briefly, what it means is what you think your annual needs will be, multiply it by 25 (100/4). That should allow you to withdraw the 4% of your liquid investments/savings each year after you turn 59, and adjust it up by inflation as well. For example, if you think you need $10,000 post retirement, every year, post taxes:

- Assume inflation between now and when you turn 59 will be 20%. This means you will need $12,000, post taxes, in the first year of your retirement.

- For simplicity sake, assume a tax rate of 40%. This implies, you will need $20,000, pre-taxes in year 1.

- The 4% rule would imply, you will need $20,000 * 25 = $500,000 saved up when you retire.

This is not an accurate prediction but a rather safe assumption. Add cushion to it if you want to play more conservative.

2) Earlier in life, take more risks — save, but invest in higher risk, higher reward investments. You can take more risks in your 20’s while you do not have many personal and family obligations. By you 30’s though, if you have not been successful in saving much (perhaps your high-risk investments went down the drain), start balancing the risk.

Ironically though, if you are able to accumulate a little wealth into your late 20’s or early 30’s, it should allow you to set aside some of your wealth for a rainy day, and take higher risks with the remainder of the capital.

3) Investments can be roughly divided in three types:

- Income. They focus on generating income. Bonds, dividend stocks, savings accounts, and rental real estate are some examples. These generally have lower risk and lower potential for growth.

- Growth. They may generate no income but optimize for growth. Of course they are also higher risk.

- Balance. These try to generate some income, but also focus on growth.

4) Even in my 40’s, I tend to largely focus on Growth, with some Balance. The idea is to build enough reserves that when I switch to Income, even at a low yearly return, my “passive” income can sustain my lifestyle.

Last but not least, I recommend you set aside enough cash (or another very liquid and near zero risk investment) that if you were to lose your job and your investments collapsed to zero, you’d still be able to go on for at least three to six months.