So why do we invest anyway?
Now there’s an obvious question, right? It’s right up there with “Why do we go on diets?” But try finding obvious answers.
Countless diets exist, coming with countless hype and countless objectives, which countless dieters do or don’t follow (especially those on the “I’m A-Gonna Wing It and Eat Fewer Donuts” plan). Lose a few pounds? Cut some cholesterol points? “Whatever. It’ll all work out!”
Maybe we think we’re on a healthy diet when all we have is a healthy imagination.
It’s similar when it comes to investing.
Too many well-intentioned investors can’t define their goals precisely. If they can, they may lack any sense of how their strategy and choices connect them to a desired result.
And even those who make it that far may put the whole thing on autopilot, never considering how market forces, emerging opportunities and suffering sectors could change their investment equation.
Then they panic and hit the ejection seat button at just the wrong time.
None of those types need to describe you. Here we’ll talk about how purpose, plan, and patience play integral, foundational roles in the smart investor’s playbook.
Taken together, they not only answer the “why” question, but also “how” and “how long.” Let’s start with perhaps the most misunderstood example.
Know before you grow: assets versus investments
The distinction between asset and investment, while simple, is far from simplistic. An investment is an item you acquire to generate income or appreciation. Different types include but are not limited to:
- Stocks (equities that give you ownership in a company)
- Bonds (fixed-income instruments where you act as a money lender)
- Options (which give purchasers the right to buy or sell a security at a fixed price)
- Annuities (purchased through insurance companies, often to provide a steady retirement income)
Now here’s where it gets confusing: all investments, once they generate a positive return or rise in value, are assets. But many assets are not investments, like a home.
With the basics out of the way, this brings us to purpose.
Purpose: Investment objectives
Before any investment produces a return, the place or way an investor plans to apply that return answers the “why” with a “because.” Some of the most important investment objectives include:
- Create wealth. Billionaire Warren Buffett famously started with this singular goal, placing it even above buying a new main home, which he last did in 1958. (Notice how he didn’t invest to buy a bigger home.) Having created more than $80 billion in wealth, he’s on course to give 99 percent of his money away.
- Fund retirement. Accounts such as 401(k)s, 403(b)s and IRAs allow employees and the self-employed to invest for retirement, with the added advantage of deferring taxes.
- Pay for tuition and education. 529 plans not only defer taxes as they grow but also allow parents to make tax-free withdrawals for education expenses.
- Produce passive income. Invested money generates income that doesn’t correlate to a standard 9-to-5. In fact, you might be able to live off it without any job at all.
- Build a business. Entrepreneurs often use investment income to jump start a new venture before they leave a full-time job.
Notice how some objectives (retirement, tuition) will lead to certain investment pathways, clearly created for that purpose, while others require more research and strategy.
No matter the goal, a plan charts a sound course for getting there.
Plan: why diversification is good
When we diversify, we spread out our investments across a spectrum of risk levels, sectors and types. It’s the opposite of that cliché of “putting all your eggs in one basket.”
Stocks capitalize on bull markets; bonds provide fixed-income stability when the bears arrive. High-tech investments could take off at hyper speed; dividend-producing stalwarts in healthcare, for example, often have unspectacular-but-steady track records that span decades.
The diversification concept is so powerful it won a Nobel Prize for one of its earliest proponents.
In 1952, Harry Markowitz (only 25 years old) developed modern portfolio theory, the idea that many investments dedicated to a single goal balance each other out, reaping the rewards of risk while providing strong roots.
Patience puts it all together
The worst investment habits and strategies center on impatience and anxiety.
Read: market timing, the theory that you can profitably buy and sell stock by predicting its future movements. If you haven’t heard it enough from us yet, we don’t love this theory.
Likewise, shares that take a beating in the short term will tempt many investors to dump them. Yet it’s also fair to ask whether it might be a good idea to buy more of that stock if it’s now undervalued.
Let’s step back and look at how many of the above investment goals have long timelines attached to them.
Over a decade or more, it’s inevitable that markets will fluctuate. On a basic level, we all have two choices: react to every changing condition and alarmist headline, or stay the course by sticking to the plan, making necessary tweaks along the way.
The latter strategy, also known as “buy and hold,” has guided some of the greatest investment minds of all time, including Warren Buffett and fellow billionaire Charles Brandes.
Patience was also the watchword of the late John Bogle during his wildly successful years at the Vanguard Group.
3 Ps, the encore
So why are you investing?
If you didn’t know before you started reading, here’s hoping you have a better idea now.
And if you did know, consider reassessing your plan and maybe even your patience. We do it all the time.
In investing and every other field, the great minds never stop learning.