By having a financial toolbox and understanding how to use the tools to your advantage, you can become financially free. That means you can start living your life on your terms!
Have you ever heard about a carpenter without a toolbox? Or a car mechanic with no tools fixing a car? No? Have you heard about a carpenter who has a full toolbox but has no clue how to use any of the tools? If you have, would you hire him/her to build your house?? I guess not!
The same thing goes in the financial world, you want to know what tools are available and then learn more about the key ones so that you can use them at the right time! If you want to hire someone to help you with the tools, hire someone who has a proven track record (don’t just ask a friend)!
Why you need a financial toolbox
By gaining the knowledge about different financial investments available and learning more about them, you can use them to your advantage. If you want to become financially rich, this is a must (at least if you want keep and/or grow your wealth). Millionaires all know about a multitude of different investments (tools) available at their disposal. They might not know everything but they know the basics and that means they are in the game. If they want to know more, they can always learn or they will just ask an expert they trust.
Key point is that they have enough knowledge to understand if the particular investment is interesting enough to learn more about or pass on. Their toolboxes are normally very wide and they tend to diversify their investments (using many different tools).
The key tools to understand (to have in your financial toolbox)
Here I will give you a glimpse into the ones I think you would benefit knowing about (not an extensive list by any means) and then I will let you explore further on this platform. This is my personal understanding and the information given is NOT comprehensive but intended to give you an idea of how these assets work. I would suggest you use my online wealth sessions for a deeper session on these specific assets.
You really should understand what bonds are, how they behave and why, because they are very likely to be one of your investments once you start investing. Simply put a bond is a security you buy which pays you a coupon (interest), normally once per year and at maturity (bonds normally have a fixed tenure) the nominal amount. The bond can be issued by a corporate, like Apple, who will issue (sell) the bond to get money to use in their business. As the investor you take the risk that Apple might not be able to pay you the coupon, nor the nominal amount at maturity. A high risk name should pay a higher coupon than a low risk name. The value can go up and down but normally it will not go above the nominal amount (as that is the money the investor will be paid back at maturity and that value is known to all investors). Therefore, your potential profit is limited to your coupon if you buy the bond when the company, municipality or government issues the bond and then keep it till maturity (this is different if you buy on the secondary market). One important aspect of bonds is that when interest rates go up, bonds will fall in value and vice versa! So when one expect interest rates to go up, bonds are likely to fall and the longer the maturity of the bond, the more it will fall in value. This is a very important point which unfortunately most people do not understand. This is further explained in our training sessions.
A stock represents an ownership. So if you invest in the Apple or Coca-Cola stock, you actually own a piece of that company! That means that if the company is doing great or the market thinks it will be doing great, the price of the stock might increase and you make a profit (if you sell) and vice versa. Some companies also pays dividends. If a company makes a profit they might pay a dividend (like interest) to its shareholders. Every stock has specific risks and investing in stocks can be very, very risky and you can lose all your money if the company goes bankrupt. The upside, on the other hand, is unlimited but again, you can lose it all so you have to be very knowledgeable before investing in stocks. You need to make sure it is suitable for you to make the investment. Over time, owning stocks has been an amazing wealth builder as it lets you be a passive investor. I would actually dare to say that all wealthy and successful people own stocks!
This is a security with multiple holdings (investments) and it is the most commonly used investment in pension savings (be aware of your costs!). They have one or several fund managers who are buying and selling stocks (if it is an equity fund), trying to make money for the investors. They have fund rules to follow and these can differ significantly between different funds. This means that there are funds focusing on different assets, sectors, countries, strategies etc. and this also means that the risk can vary massively between one mutual fund and the other. The good thing about mutual funds is that you can invest very little money, often less than 100 USD and immediately get small pieces of all the holdings of the fund. This means that you don’t have to buy a lot of stocks individually to spread your risks as the fund manager does that for you. The main negative with mutual funds is that they tend to be very expensive, charging an annual management fee normally between 1 – 3% per year and this is regardless of their performance! As we have written quite extensively about before, the amount of fees you pay have a significant impact on the value of your assets. You have to make sure what you pay is reasonable and that it makes sense. Nowadays it is quite easy to compare funds, returns and fees, using a site like morningstar.com for example. If you only take one thing with you from our platform, I hope this point is the one. The money you pay away in fees are money which I think should be in your pocket!
Exchange Traded Funds (ETFs):
They are very similar to mutual funds as this is a security with a collection of holdings. The main difference is that they don’t have a fund manager who is deciding when to buy and what to buy. This is predetermined and done by a computer. Since they don’t use a fund manager, the costs are normally much, much lower. The annual fee tend to be in the range of 0,1 – 0,50% per year. As you can see, you can save a lot of money every year in just fees by swapping your expensive mutual funds to ETFs. However, this only makes sense if the risk is the same and so is the performance before fees. Then it can be a massive saving over time! The rule of thumb is: if you save over 30 years and manage to get 8% per year in return, a 1% fee will eat away 20% of your money! Even worse, a 2% fee will take away 40% of your money!! So if you can lower your fees with 1 % (I know it might not sound that much but…) and with the above numbers, your pension pot could be 20% higher when you retire! I personally use ETFs quite frequently because of the benefits of instant diversification together with low cost and these can be bough via your bank or online broker like any other investment.
These are investments which are not supposed to perform in tandem with the stock market. The idea if having them in your portfolio is to spread your risks and not relying on the stock market always performing. These assets are often looked upon as investments that should perform when others are not (so off-setting to some extent). There are also investments which call them selves “Absolute Return”, having the intention to always show a positive return in any and every market scenario but in reality very few manage to deliver on this.
There are numerous variations within this space but some of the most common ones are: commodities (like oil or gold), hedge funds, infrastructure, properties, private equity and within these assets there are numerous strategies. I am not going to go through the specifics of these and again, these are just a handful and there are many, many more.
Each successful person uses different tools
Everyone who becomes successful will have learned to use a variety of tools, regardless of what they do. They will learn and try new things until they find a mix that works well for them. That is when they become an expert or a success in what they do. Investing might just be a small part of what they do but all successful people who also make a lot of money will apply the same technique here. This is to learn what they feel they need to learn to be in the know (creating their own basic fanancial toolbox) and then use experts to get the depth needed (depending on their level of interest).
We have now gone through some of the most common investment tools that you most likely should understand and have available in your financial toolbox. I purposely excluded savings accounts which is the most common of them all because we all have them and they’re not the ones that will make you wealthy, although you should probably use them too (check out our Bucket System). How you choose to use these assets should be based on your risk and investment profile, which is unique to you and your personal circumstances which means you should talk to your financial fiduciary (but make sure to keep your costs down).
The deeper your understanding of the basics of these tools, the better as then it will be very easy to compare different variations and/or specifics of different investment alternatives, so the sooner the better!
One comment about funds in general (both mutual funds and ETFs) are that when you buy these, you get instant diversification, which is great. Instead of you trying to figure out which stocks to buy in a specific country or sector and then buying some of them, you can just by an ETF. Normally they have 50-500+ holdings and also limitations as to how much they can own in one single asset (low concentration of risk). Therefore the risks are spread immediately amongst the holdings and that lowers the risk for the investor compared to just buying one stock in Microsoft for example.
Some have said that diversification might be the only free lunch you get when investing. True or not, I like diversification as I know I will be wrong and some investments will go down in value but that is just part of the game and in the long run I am confident passive investment in securities is a good place to be.
I am personally investing in all of these asset classes and continuously looking at new potential investments. In general I prefer ETFs as they can give me quick exposure and diversification at the same time which means I don’t have to look at specific stocks myself and buy them individually. ETFs are much cheaper than mutual funds and I prefer to keep the majority of money in my pocket. Still I have a few mutual funds in my portfolio and that is because they give me access to a specific type of asset and I deem the management team of the fund worth the money, else I would buy a similar ETF.
My investments are based on my personal preferences, risk willingness etc., something individual and personal which is very important to bear in mind.
As always, acquire the knowledge, create a plan, automate and execute!
I don’t mean to give recommendations in this post, these are just my general thoughts and there might be mistakes and incorrect information so you should always consult a financial fiduciary prior to making any investment decisions so that they are the right ones for you based on your personal circumstances.
Actions to take:
- Go through our free webinars and learn it from scratch!
- How to always have enough money!
- Passive income and why you must care!
- How to Change your money mindset
- Are you giving away HALF your PENSION (in investment fees)?
- Are you making money whilst sleeping?
- The 10 Key Questions I ask before making an investment
- Why Warren Buffett recommends Exchange Traded Funds ETFs
- Why you should have an investment account with your partner
- How to become financially free in three steps
The sooner you learn the financial language the faster your route to financial freedom and a life on your terms. We are here to help!