7 Investing

Short term assets are held to be used, either for known expenses in the near future or in case of a sharp economic downturn or unexpected emergency.  In stable sectors of the economy (in which workers can anticipate finding a new job quickly) finance experts recommend saving several month’s living expenses in an emergency fund.  In the event that a job is suddenly lost or circumstances necessitate a sudden upheaval, such a fund can help avoid significant negative impact.  For those who are more wary of employment prospects, a larger emergency fund (4-6 months instead of 1-2 months) can provide a sense of security.  Each individual must balance their comfort with the potential risk of suddenly losing income against the need to invest money back into the business.

Because security and liquidity are central to the needs of short-term investments, vehicles should prioritize these features.  For security: the Federal Deposit Insurance Corporation (FDIC—an independent agency of the U.S. government, created by congress) protects certain investments up to a maximum threshold that has increased over time with inflation.  In 2022, the FDIC insures up to $250,000.00, per depositor, per FDIC-insured bank, per ownership category.

Not all assets or banks are protected by the FDIC, but certain asset types tend to be insured.  Before trusting that an asset is safe, confirm that the institution under consideration is FDIC-insured and that the particular asset under consideration is insured.  Among insured assets are savings and checking accounts, which are among the most liquid—meaning the asset can be quickly or immediately withdrawn and used as cash currency.  When money is given to a bank to store in a savings or checking account, the bank pays interest to the investor as a fee for temporary use of the funds, and the investor benefits from the security of keeping money in a safe place (physically safer than keeping cash in a coffee tin, and—in theory—completely safe up to the current FDIC threshold if the account is FDIC insured).  Because the account holder expects expeditious access to their stored funds, the bank is not able to lend out the funds to other companies or individuals and therefore cannot charge interest and turn a profit; as a result, these financial instruments offer abysmal interest rates—sometimes as low as a basis point (0.01%).

Historically, the Fed has aimed to keep inflation to about 3% each year, meaning the same goods that cost $1,000 today would cost $1,030 a year from now in ideal conditions.  The same $1,000 in a bank account paying 0.01% interest would be worth $1,000.10 a year later, even though the cost of goods rose to $1,030.  Keeping money in low-interest bearing accounts over time erodes spending power, meaning when an asset fails to keep pace with inflation it is worth less compared to the value of goods and services.

Some money-market accounts offer an alternative for short-range assets—money market accounts seek to pay an interest rate of 1%, which still loses spending power compared against even tame inflation, but 1% represents less of a loss against inflation than 0.01% offered by some bank accounts.  Not all money market accounts are FDIC-insured, and they may impose limits on how much or how often assets may be withdrawn.  Likewise: a Certificate of Deposit (CD) account represents an agreement between an investor and a bank, wherein the investor agrees not to withdraw any funds for a pre-determined period of time.  This gives the bank bandwidth to invest or lend the asset elsewhere and make money, which allows the bank to pay a higher interest rate to the investor in exchange for temporary use of the money.  Interest rates for CD’s are generally higher than savings or checking accounts, and higher interest rates may be locked in by agreeing to deposit the funds for a longer period.

Some cautious investors prefer to use “CD ladders,” wherein CD’s are purchased every few months and expire every few months, giving the investor constant access to some portion of the total asset value while still capturing the respectively higher interest rates offered by CD’s.

For mid-range assets, a more aggressive investment approach is typically considered- time is the investor’s most valuable tool, but time is also an unrelenting adversary when the erosion of spending power is considered.  Over five or 10 or 15 years, that same baseline inflation rate of 3% turns what would cost $1,000 today into $1,160 (five years), $1,345 (10 years), and $1,560 (15 years); whereas, $1,000 in a bank account paying even 10 basis points (0.1%) interest would be worth $1,005 (five years), $1,010 (10 years), and $1,015 (15 years).  After 15 years, the same $1,000 in a bank account is worth: [latex]$1,015÷$1,560=0.65[/latex], or 65% of what it could have bought upon being deposited.  FDIC-insured bank accounts are—for most—the safest place to store money; but, over longer time periods, money is worth less and less after sitting in a low-interest bank account.

The goal of mid-range time horizon investments is to keep pace with inflation or gently exceed inflation; this can be achieved by investing in financial instruments that are linked broadly and directly to the economy.  Typical investment vehicles are stocks, bonds, and mutual funds.

A stock represents a share of ownership in a company; shareowners are entitled to benefits that can include voting rights, dividends, and capital growth if the company performs well and shares become more valuable over time.  Stocks are among the more risky investments when purchased individually, meaning that there is potential for any one company to dramatically lose (or gain) value in a short time period and independently of the wider market.  An executive taking to social media on a tirade against their company can cause the market’s valuation for shares in a stock to plummet overnight; but, a company which innovates and produces products that fill a unique void in an untapped market can appreciate (rise) in value meteorically.

In terms of their volatility, individual stocks tend to (by definition) vacillate more tumultuously than the average of all stocks.  When one company might has a uniquely bad day, most other companies might be performing as usual. For most individual small business owners, investing is a means to protection against the erosion of value in assets; investing is not the ends itself, and small business owners are unlikely to devote daily or hourly attention to current events in the stock market.  Therefore, it is rarely prudent to invest in only one company, or even a handful of seemingly well-chosen companies.  Mutual funds pool together money from many investors, allowing a professional fund manager to purchase shares of many companies at once and allocate a portion of the ownership value to each individual investor, even if the individual does not have enough money to buy full shares of thousands of different companies at once.  Fund managers can have active or passive approaches, and they can charge a small fee for their professional oversight.  Mutual funds can be made up of stocks, bonds, and other more intricate financial instruments; but, it is through this lens that discrete features of stocks may be examined.

Key features of a stock include: price, or the amount someone is willing to pay for a share of ownership in a company; shares outstanding, or the total number of shares that currently exist; earnings per share (EPS), which is a ratio of company profits (earnings = revenue – expenses) against the total number of shares; price/earnings ratio (P/E), which relates the earnings per share to the market value (price) of each share—in other words, how much are you willing to pay for each dollar of profit the company is earning? Stocks may also be described using broader terminology: value stocks are bought because they are perceived to be currently trading at a low price compared against their intrinsic value; growth stocks are purchased for their potential growth.  When a company earns more than it spends each year, it may reinvest its profit into the company to foster an innovative environment (as Apple did for many years under Steve Jobs), or it may pay share owners a portion of that profit in the form of a dividend.  Companies that pay regular and large dividends are known as “cash cows,” and the dividend yield may be calculated by dividing the total yearly dividend by the current share price.

Stocks and mutual funds trade on stock exchanges, commonly including the New York Stock Exchange and the NASDAQ; these exchanges maintain the infrastructure that makes transfer or assets and ownership possible; but, to execute a trade, investors place orders through their stock broker. Companies that trade on exchanges are listed using a ticker symbol, or a shortened identifier; some mutual funds and electronically traded mutual funds (ETF’s) also trade using ticker symbols for easy identification.  Online finance resources make quick work of accessing historical and statistical data about such financial instruments.