This is a part of the Investing Series.
You may be wondering at this point how you can even figure out what kind of investor you are, if you are just starting out in investing.
It’s like trying to figure out what you want to cook as a 3-course meal when you don’t even know how to boil water or fry an egg.
Side note: I love to trot out this story, but I knew girls who thought hardboiled eggs were whole eggs you put in a frying pan with their shells still on. *shakes head*
In actuality, figuring out what kind of investor you are really isn’t as hard as it may seem and it is something you SHOULD do before you even think about investing.
You just have to ask yourself a few questions (honestly) about your situation and what you are comfortable with in terms of how much of a risk you are willing to take with your money.
Here are a few questions you can start thinking about to get a feel for what kind of investor you are.
1. HOW OLD ARE YOU?
I’m not trying to be fresh, I promise!
I know it’s impolite to ask people their age, so I’ll just give ranges so you can keep your anonymity (you all look 25 to me, anyway!):
If you are around the age of 35 – 40 and younger, you can afford to be riskier with your holdings in your portfolio, and put it into index funds, stocks and dividend-paying stocks or funds.
This is because you have time on your side.
If the stock market tanks or takes a dip for 3-5 years and takes 10-20 years to recover and grow, you can afford to ride out the wave by continuing to save your money and invest it.
Now if you’re 40 and older, you’re about 25 years off from a generally accepted “retirement age” of 65; you might want to start weighting your portfolio closer to steadier streams of income, such as bonds, so that the money is ready and available when you do decide to call it a day.
Otherwise, consider working longer.
2. WHEN DO YOU WANT TO USE YOUR MONEY, AND WHAT FOR?
Now all this saving is great, but eventually we have to get to the point where we want to use the money.
So when do you want to use your money?
At retirement? Okay.
At what age do you plan on retiring? Do you ever foresee yourself wanting to retire earlier?
When you retire, what do you want to do with that money?
Sit around at home and potter around a garden?
Take a cruise?
These are all things you have to think about as part of what kind of investor you want to be, because everything costs money.
For investing, you don’t necessarily have to always think of it as retirement money, maybe you want to invest your money so that you can leave your job and start a side business.
Or maybe you want to take a year off and travel, but your job doesn’t offer sabbaticals or any kind of leeway and you’d actually have to quit before you could do that.
Other things to consider would be if you wanted to put down a down payment on a house, or pay for your children’s education — all of this comes out of your savings, which are (hopefully) invested, so that when you are ready in 10 – 40 years to do what you want with the money, it’s there for you.
3. IF YOU LOST HALF OF YOUR MONEY TOMORROW, HOW OKAY WOULD YOU BE WITH THAT?
If you answered:
Yes, I still have time to build everything back up, and I am totally fine with this!
*nervous smile*…. *fidget fidget*
.. then you are a riskier investor and can afford to invest in stocks (a.k.a. “equities”) and index funds over bonds.
If you answered:
OH HELL NO.
I’m 10 years away from retiring, and I AM NOT willing to lose half of everything I worked for.
…then you aren’t a risky investor, and you should think more about bonds, but especially about INDEX funds.
Case in point: Don’t put all your retirement fund into an Apple basket… literally
I read on the investing forum comments once, about a guy who had $1.6 million saved and was in retirement already. He wanted to grow his money (STILL) even in retirement, so he bought 3200 shares of …. wait for it… APPLE.
3200 shares x $500 = $1.6 million
(Yeah I custom-made that image for this post. Cool huh!?)
Almost a month or so after, Apple started to waver and drop in share price down to about $439 because the Wall Street people were all saying that “a technical analysis of Apple shows that they’re overvalued“, which is Wall Street gobbledegook for:
“SELL NOW. APPLE IS DONE. FINITO!
They ordered less screens from Foxconn for their iPads, iPhones and iPods. GET OUT!!!!
*plays doomsday music*“
Some investors, like a bunch of wildebeest following a crowd, starting selling their shares, and it went from $500 a share down to $439 or so, and the shares of Apple are still dropping ever so slightly as I’m writing this post.
Other investors were saying that Wall Street was screwing around and trying to turn a quick profit by scaring people off the stock, buying it when it goes below $400, and catching the upswing when they then turn 180 and say: NOPE! Guess we were wrong! Apple is on the rise again…
Anyway, as all of this is happening, that guy in retirement, lost on paper about $195,200 in a span of a month or so.
He started asking around if he should get out now with his money somewhat bruised but still intact, or wait for the upswing that other investors were sure was going to happen because Apple makes a serious profit margin on all their products.
It became a whole discussion topic about people being quite alarmed he had done that with his retirement savings, and telling him he should talk to a financial advisor, STAT, and/or switch out his money into bonds to preserve his wealth.
I don’t know how the story ends because after reading that, I was already in the corner breathing into a paper bag, but if it made your heart jump the way mine did, you would be wise to remember to STRONGLY consider switching your portfolio to bonds as you age.
Above all, and even if you forget everything I’ve ever told you — please don’t put your retirement money into one single company.
If that is not the epitome of all your eggs in one basket, I don’t know what is.
Hindsight is 20/20.
The story could end very well, the guy could end up making $320,000 if the stock price goes up to $600/share, but it could end very badly if it drops down to $300/share or starts in on a low, slow, decline.
4. HOW DO YOU PLAN GETTING YOUR RETIREMENT INCOME?
Are you sharing the retirement fund with someone else?
Do you want to have a steady income coming in from all your investments so that you don’t have to sell anything?
Or do you want to slowly deplete your assets at a rate of about 4% a year, and whatever is left goes to your family?
If you like the idea of making an income from your investments, aside from buying real estate and collecting rent money (assuming the mortgage is cleared), you might want to think about a dividend-paying stock portfolio, where you get money every quarter (or whenever the company pays them out) for holding stocks.
Still, I would never in a million years ever recommend that you put 100% of your money into dividend-paying stocks ONLY, because that’s just as risky as it is still invested 100% in stocks.
The only time it would make sense, is if you’re an heir or heiress and you inherited those shares and you are dancing footloose and fancy-free on capital and “free” dividends that has been earned by someone else.
If you earned that income, and THEN put down capital to buy those stocks, it’s another story for me, because you (may) only really get a few pennies of dividends per stock, which may not be your thing if you don’t want to wait for this strategy to pay off.
A lot of the wealth on the stock market (if you look at the Total Return of the S&P 500) has been from buying dividend-paying stocks, and re-investing them.
In fact, S&P says about ~40% of the return has been from dividends!
The hardest question then becomes: Which ones should I buy, and which ones are sustainably going to pay me dividends over the long-term?
If you can’t answer those questions, then consider this:
$0.04 in dividends / $50 for the stock price = 0.08% return on your money every quarter
Sure you can find high-yield dividend-paying stocks that you can buy forever that pay out a 6% yield or higher, that’s great, but you have to search for them AND you have to keep on top of them to make sure the company wasn’t lying (read: desperately giving dividends as bait) and is about to go bankrupt.
You also want them to increase their dividends over time, otherwise other companies look better.
Until you get to the point where you have enough money that you have a solid strategy for your retirement fund going forward, and you have the time (and interest) to hunt down good dividend-paying stocks, you should stick to something simple until you can master it.
Like index fund investing.
It’s a good strategy to have dividend-paying stocks IN ADDITION to your other investments that are diversified throughout index funds, bonds and stocks, but it shouldn’t be your be-all and end-all.
Otherwise, if you just want to deplete your assets, you need to know how much will be left, growing at least to combat inflation each year (average of 3%), so that there’s enough to last by the time you kick the bucket.
This brings me to my last question..
5. HOW MUCH DO YOU NEED FOR YOUR RETIREMENT SAVINGS?
This might seem kind of stupid in a list of questions on what kind of investor you are, but you need to be well aware of what kind of GROWTH you need to reach your goals.
Let’s take an example.
If I have about $10,000 saved at the age of 25, and I save about $10,000 a year until I retire at 65 (40 years), here are the growth rates I need:
- At 1% growth rate = I will have about $506,490.01 (but you’ve lost money to inflation)
- At 3% growth rate = I will have $804,864.65 (but you really have a real return of 0%)*
- At 5% growth rate = I will have $1,345,262.55
- At 8% growth rate = I will have $3,151,895.41
* 3% is just on par with combating average inflation rates of 3%, which makes your money growth equal to a big fat 0
As you can see, how risky your investments need to be, factor into how much you will have at the end.
If you figured out that you need to have at least $1 million saved by the time you retire, then your money needs to return about 5% on average over the 40 years, or a real rate of return of 2%.
This means you can’t just stick your money in bonds or high-interest savings accounts that return 1% – 2%.
That barely even covers inflation at 3%, but more importantly, you will miss your retirement target of $1 million by about 50%!
Of course, you can also help this number along by saving MORE than $10,000 each year for 40 years so that even if it returns 1% it’s doable, but this is just an example.
WHAT IS A ‘REAL’ RETURN VERSUS A ‘NOMINAL’ RETURN?
A real rate of return or “real return” means it takes into account inflation eating away at your money each year.
A nominal rate of return or “nominal return” doesn’t take inflation into account, and that isn’t realistic because as we all know, things that used to cost pennies in the 1950s, now cost dollars to purchase.
HOW WOULD I ANSWER THE ABOVE QUESTIONS?
If you want a real-live example of how I’d answer the above questions so you can follow along, here it is:
1. How old are you?
I’m just shy of 30, as of this post date.
2. When do you want to use your money and what do you want to use it for?
I want to use it when I’m around 55 – 60 years old, and I want to use it for retirement.
I am not actually sure that I want to retire so early at 55, but it’s nice to save money and work towards that option in case I change my mind.
I also want to retire overseas, I’m not keen on staying in Canada at all, so I’d need to also make sure I have some money set aside so I can pay for accommodations overseas.
I’m also thinking it’d be nice to travel a bit, but as I’m older, I wouldn’t want to travel too often or walk too much, and therefore I’d more than likely need more than just a week to see a city.
3. If you lost half your money tomorrow, how okay would you be with it?
I can stand losing 10% – 25%, but 50% is just bonkers.
This means I am a moderate investor, but not a risky one, and I want growth, but some kind of stability as well that my wealth won’t vanish over night.
I’d rather have lower gains and returns on my investment, than risk my pot of money.
4. How do you plan on getting your retirement money?
I plan on withdrawing about 4% of my retirement cash each year, and using that to live.
If I need more, I also need the option of being able to pay for my nursing home so I’m not a burden on my future kids.
I am also not relying on anyone else (including the government) providing the money for me (it’s never good to be dependent on anyone or any institution), so whatever I save alone, is what I can afford for my retirement.
I’m also a freelancer, so I’m totally on my own for retirement savings. I can’t count on company pensions nor Canadian government aid in retirement either.
This image is just for fun. It has nothing to do with this post except that it’s Canada-shaped.
The average Canadian can expect to get about $33,500 if they earn about $100,000 as a household income when they retire due to:
- Company pensions
- Canadian Pension Plan (CPP)
- Old Age Security (OAS)
Let’s say they live to about 82 years of age (average life span of a female Canadian), and retire at 65; that’s about 17 years of living expenses paid for.
17 years x $33,500 = $569,500
If you need about $50,000 a year to live “comfortably”, then you need to have saved an additional $16,500 alone, above and beyond what you can expect to get, for each of those 17 years.
17 years x $16,500 = $280,500
$569,500 + $280,500 = $850,000 saved for retirement
(for an average 6-figure income Canadian couple)
But again, since I’m not counting on any of that money to help boost my retirement savings, I know I need to save AT LEAST $850,000 all by my lonesome to have a shot at retirement by the age of 65.
5. How much do you need for your retirement savings?
I’ve always had about $1 million in my mind as the target goal, but I’m thinking that $1.5 million is probably a better bet because I do want to move overseas and perhaps buy (or rent) a small place to live out the rest of my years.
Also, $1 million was based on retiring at 65 I think, and if I want to retire earlier as a conservative estimate, I’ll need more money, and $1.5 million sounds better.
Currently, I’ve saved about $50,000 a year on average, and if I am able to keep up this rate of savings for the next 26 years, these are my growth numbers if I want to retire at 55 (conservative age):
- 1% = $1,743,303.91 saved
- 3% = $2,401,450 saved
- 5% = $3,391,275.59 saved
- 8% = $5,933,253.78 saved
As you can see, if I want to meet my goals I HAVE to save $50,000 on average after taxes, and it has to grow at least 1% for about 26 years to retire at 55.
The good news is that I’m young, so if I assume my nominal rate of return will be around 5%, and I should be on track to have ~$3.4 million by the time I retire at 55.
This is retirement savings overkill, but I’d rather kill it than miss it.
- Knowing what kind of investor you are, is like learning how to crawl before walking
- Understand what you need that money for, when you need it, and how you’ll get it
- Risk has everything to do with how much growth you want; riskier investing = growth potential
- Know your retirement numbers of how much you need to have saved for retirement