Introduction to Investment Concepts

Introduction to Investment Concepts

There is no need to recreate introductions to investment concepts – there are plenty out there online, like napkinfinance.com. Instead what I thought I would do is curate some concepts I feel are important to know on this page.

napkinfinance.com have used a lot of napkins to explain things and I suggest you bookmark their website, especially the following links: money-101 and investing

I start with a few general concepts, then briefly cover some strategies, explain the different assets / investment options, summarise ways you can earning money, and lastly explain a few key calculations.

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General Concepts

Investing

Investing

Very high-level overview of investing, what it drives and how it benefits both the investor and the receiver of money.

Bull&Bear

Market Types

What is a Bull & Bear Market? There are two types of markets, a market that is in an upward trend (Bull) and a market that is in a downward trend (Bear). As an investor you have to be comfortable with both and be able to see the opportunity and risk present in both situations.

Volatility

Volatility

Volatiolity refers to the frequency and size of movements in markets (up and down). As an investor you’ll need to build your portfolio to be resistent to these swings (diversified) and learn how / when to see both the highs and lows as opportunities.

Risk_v_Reward

Risk vs Reward

Generally it is assumed that the higher the risk, the higher the reward. But that is not how the super wealthy operate – they look at how to invest in asymetric risk, or reduce their overall risk while increasing or maintaining the rewards on their portfolio.

Risk_v_Reward

Opportunity Cost

Every decision we make has an opportunity cost. For example, decidign to go see for a dinner and a movie instead of saving some money. Opportunity cost is the “price you pay” for doing one thing over another.

Risk_v_Reward

Fees

Fees are an important consideration when chosing your invesment platform, your financial advisor (if you opt to use one), your asset type/class, our frequency of trading, your bank account, etc. The graph on the left shows the impact of just 1% over 20 years will reduce the potential future value of a £100,000 investment  by £75,000. Imagine what difference a 3-4% difference in fees will make!

Strategies

Stocks

Asset Allocation

Investing in different asset classes is a form of diversification, by investing in for example stocks and bonds you reduce your overall risks and reduce the senstivity of your portfolio to market movements. Ray Dalio has shared with Tony Robbins in his books Money: Master the Game and Unshakeable what his All Weather Portfolio looks like.

Diversification

Diversification

Looking at diversifications more broadly, this takes into account asset allocation, countries, currencies and timing (when investments mature). This strategy should not be underestimated.

Rebalancing

Rebalancing

Due to your portfolio performance (up & down) you’ll need to schedule periodic rebalancing to ensure your overall portfolio meets your asset allocation and diversification targets. Keep in mind that this will attract transaction fees as you buy/sell. I would recommend a quarterly review to assess if rebalancing is required. Without rebalancing your portfolio you may be unwittingly exposed to higher risk.

Shortselling

Short Selling

Short selling (made famouse by the movie The Big Short) is when you bet against the market. A recent example of when people have shorted a specific stock is Tesla – having had some exponential growth from late 2019 to mid-2020 a lot of investors have shorted the stock hoping it would crash to below their short to then make a return on the dip.

Different Assets / Investment Options

Asset Classes

Asset Classes

Quick overview of different assets that are the ‘building blocks’ for your portfolio. Each has a different time horison and risk profile that will need to be considered for your specific needs and goals.

Stocks

Stocks

Stocks (or equity) is a type of assets in which you can invest in. having bought a stock you effectively own a part of a company (hence the name: share). Having a share will in most cases provide you the right to vote on certain key topics in the company’s AGM (annual general meeting). There are different classes of shares, for example Google has A-class and B-class shares – each coming with different voting rights.

ETF

Exchange Traded Funds (ETFs)

ETFs are a collection of assets that aim to replicate a specific market, country, or industry and are traded frequently – which is the main difference with mutual funds.

Index Funds

Index Funds

Created in 1976 by John C. Bogle, Index Funds are a collection of shares that track a specific index (FTSE100, S&P500, etc). They tend to have lower fees associated with them as they are not actively traded funds (the top 100/500 firms rarely change). And even Warren Buffett said that after he dies, he recommends that his wife place 90% of her assets in a low fee index fund and 10% in bonds.

reits

Real Estate Investment Trusts (REITs)

REITs are trusts which own real estate (property) and sell shares in this trust to investors. This enable people to buy a share of say a large office building without having to invest millions of Pounds themselves. As property is generally seen as safe asset (apart from the 2007 financial crisis) the returns may be low but secure.

Earning Money

Interest

Interest Earned vs Paid

The amount of money you earn for the priviledge of lending your money to others, or the amount you pay other for the benefit you received from using their money do buy something.

Compound-Interest

The 8th Wonder of the World

Albert Einstein famously once called Compounding Interest the 8th wonder of the world. Slow and steady, when consistent over a reasonably long time, will beat most “get rich quick” tricks.

Dividends

Dividends

Dividends are a share of the profit a company that is distributed to shareholders. Companies usually don’t distribute 100% of their profit. Dividends are paid quarterly in most cases and you can find the latest declared dividends for the UK markets here. Worth noting that the term ex-dividend means the date up to when a share will be eligible for the next dividend payment, if you buy a share after the ex-dividend date you will not be eligible for the upcoming dividend.

Calculations

Rule of Thumb

Rule of Thumb

A quick calculation to determine the time it will take to double your money at a specific rate or earning (interest, dividends, growth, etc).

IRR

Internal Rate of Return (IRR)

IRR is a way to compare different investments by expressing them as a % return (or value earned) over a set timeframe. As a percentage it is easier to compare. IRR is less useful when used on its own and for a single investment (without a benchmark / target).

Yield

Yield

Income from investments can be expressed as a yield percentage. For example dividends have an associated dividend-yield to help you compare different investments based on the income they are looking to generate.

EPS

Earnings per Share (EPS)

EPS is another way to compare different investments, expressed as a currency value of profits over shares. So if a company made £2M profit and have 1M shares in circulation (sold) then the EPS would be £2/share.

ROI

Return on Investment (ROI)

ROI is effectifly your profit/loss ratio on a particular investment taking your income and costs into account. This helps account for other situations where certain investments have higher costs that would otherwise be hidden if taken purely in a return (income) basis, e.g. EPS or Yield.