Financial Literacy for Dummies aka Me (Week 5)

Introduction

Talking about money has always been kind of dirty in my mind. The idea of wanting more seems “greedy” and so when my family lost a bunch of money after working with a financial advisor a few years ago, my parents took it as a sign to just hunker down and save instead of investing. As I got older, I realised I was extremely avoidant when it comes to money. This avoidance also led to a lack of basic understanding of the mechanisms of investing. Hence, I am kickstarting this Financial Literacy for Dummies series as an accountability goal this second half of 2023. With education, I hope to become more educated and more realistic about investing (as opposed to extreme risk aversion).

How I plan to go about this is to read Investing 101: From Stocks and Bonds to ETFs and IPOs, an Essential Primer on Building a Profitable Portfolio and provide my learnings as well as additional notes on topics mentioned.

Exchange-Traded Funds (ETFs)

Mutual Funds are funds that trade on the open exchange. They are like buying stock but instead of an individual fund you are buying, you are purchasing a basket of securities. Some ETFs represent indexes and hold the securities in the said index.

But doesn't that sound awfully like Mutual Funds?

Although the financial product offered as mutual funds and ETFs sound similar, there is a marked difference:

1. Mutual funds are directly bought and sold with mutual fund firms whereas ETFs are bought and sold through exchanges
2. The cost structure is different between the two. ETFs are usually bought through a brokerage, at which a brokerage fee is charged. The structure of mutual funds might vary a lot more.

⭐️ Since ETF investing might incur a fixed fee (depends), it might be the case that the brokerage fee takes a huge percentage of the trade. Always evaluate the cost of the transaction as part of the consideration.

• Also check the trading fee, mutual funds and ETFs of the same basket of goods that might not trade at the same price. Calculate the overall best value for your products.

⭐️ Always take note of the securities included in the fund, overlapping securities might result in overconcentration.

Considerations for an ETF

Understand that ETF management structure! ETFs are managed by ETF sponsors and making sure that the number of shares in the market is large, ensures the liquidity of your fund. If the offering is too small/trading volume for the fund is too small, you may find yourself illiquid.

Investopedia

Active ETFs tend to require more attention from the customer. Instead of having fund managers actively managing your fund, you are in charge of managing it.

Best practices

1. Set clear investment goals
2. Opt for quality investments — a few great funds > many mediocre funds
3. Value fund category vs fund style — choose the objectives of the funds, not investment style (with caveats as to who the manager is)
4. Avoid duplication of assets — this prevents bloating of fees, overconcentration etc, each fund should contribute something meaningful

• Look at the fund objectives on the prospectus — is it aggressive, income? Make sure you find the correct fund that suits your investment objectives.
• Do not focus on past performance — future performance might not be indicative of the future (and so do rankings and ratings)

What is important?

• Each fund’s operating expenses, fees, and sales charges
• Any taxes due based on the fund’s distributions
• The size of the fund
• The age of the fund
• Any changes in fund management or operations The fund’s volatility and risk profile

Six investment Strategies recommended by the book

1. Start as early as possible. Starting early allows you to make the most of the compounding interest effect. It also allows you to start learning the ropes of investing. Early gains are the easiest way to make some strides at the start of your career.
2. The more money you put into investment, the more you earn/learn to become a better investor. This also has the side benefit of minimising your spending on useless expenditures.
3. Learn as much as possible and constantly. Keeping up with the current climate and also how your decisions will make a difference is extremely important.
4. Be aggressive at the start of investing.
5. Be meticulous about your money. How much is going into the cost? Are there receipts for your investment? Is it being invested correctly? Is the performance reflected correctly?
6. Compare the fund's performance against appropriate indexes and similar investments. Are they performing as expected? Are the costs commensurable with the results?

A brief note on value investing

This investment was popularised by Warren Buffett. It is based on the centralised ideology that one should invest in companies with an intrinsic value higher than reflected on the stock prices. He believes that over time, the market will correct itself and start valuing these companies at their true price. Well, there are asterisks in the assumptions above. First, you will be able to see through to the point when the market reaches equilibrium. Second, you are indeed valuing the company correctly, you are holding a contrarian opinion after all. There is a likelihood that you may be wrong.

A brief note on growth investing

Usually looking for younger companies with a lot of potential. They tend to be risky as they are developing cutting technology or in a new/niche industry. They may deliver upsized returns but present a huge risk of going bust completely. It emphasizes the value of a company in the future, which distinguishes it from value investing which looks at the intrinsic value of the company presently.

They concern themselves with questions about future profitability, costs, projected revenue and prospects to enter into new markets.

A brief note on technical investing

This company relies on indicators. Quantitative instead of more qualitative facts. They are looking at the market activity and investing accordingly to capture market trends and bank on it — looking at price highs and lows, volume trading and short-term trends.

In next week’s edition, we will look into real estate investing. Stay tuned!