Episode: 07-11-2023 | Investing: How It Works, Why We Do It

Hosted by Kevin J. Zywna, CFP® Dollars & Common Sense · Investing: How it works, why we do it Investing Unpacked Tonight we’re going to talk about investing, why we do it, and how it works. You know, investing is a big part of our practice. And it is a big part of financial planning […]

Hosted by Kevin J. Zywna, CFP®

Investing Unpacked

Tonight we’re going to talk about investing, why we do it, and how it works. You know, investing is a big part of our practice. And it is a big part of financial planning and a big part of financial security. But we tend not to dwell on the investing part of the financial planning process on the show. Because we think that we can add so much more value through the financial planning process and financial planning strategies and techniques and tactics, that we don’t have to talk about the investments as much. And we don’t want the show to become overly investment focused. Because everyone has an opinion about investment management. And there are 1000s of different ways of doing Investment Management. But ultimately, you have to come to one particular philosophy and strategy that works that has the highest probability of success, long term.

It’s important, every now and then, to revisit some of the principles and the basics of investing. Why we do it and why it works. Because certainly I know, throughout our practice and just talking to other people in casual conversations and accurate even in some industry literature, there are a lot of misconceptions around investing, how it works, and what you’re trying to accomplish. So that’s what we’re going to focus on tonight.

Investing Options: Why Stocks Are Important Wealth Growth Vehicles

Oh, and I’m going to tailor my comments to focus on just investing in stocks or equities. And primarily US equities because everyone can kind of grasp and understand that. Now yes, there are a bunch of other things that you can invest in besides US common stocks, but they are one of the most widely available investments, and easily accessed investments that all of us have available to us. There are bonds, there is cash, there’s private equity, there’s limited partnerships, there’s gold, there’s precious metals, there’s real estate, there’s commercial real estate, residential real estate, all kinds of different things that you can invest in. But for most people, when they think about investing, they think about investing in common stock. So that’s how we’re going to limit our focus tonight.

So, the reason why we as a firm, and most financial advisors invest for their clients in common stocks, in equities, is because it’s one of the simplest, most efficient, and least expensive methods of building wealth and income over time. I’ve got to say that, again, the reason you, me and professionals invest in common stocks, is because it’s the simplest, most efficient, and least expensive method of building wealth, wealth and income over time. It is also one of the most highly reliable forms of investing over time. And that is borne out in the facts.

Investing In The Stock Market: A Proven Wealth Growing Tactic

It’s difficult to even argue that the long term growth rates of US common stocks are anything but positive. In fact, you go back over the last 100 years, and if we take the S&P 500 index as a measuring stick, then over that last 100 years, the S&P 500 has compounded, on average, almost 10% per year. 10% growth rate per year, on average, out of the 500 largest companies in the United States. That’s the statistically factual statement.

That means you people who have invested for a long period of time in US common stocks have outpaced the rate of inflation, long term rate of inflation, which is 3% by 7% per year, on average. And it’s important to always compare your rate of return on any investment to the inflation rate. Because as the price of goods and services is inflating, is increasing, then if you want to build long term wealth, then you’ve got to surpass the rate of inflation. If you put your money in a bank account earning 1%, and inflation rate is 3%, then every year, you’re losing 2% of purchasing power. Now, you might think your money is safe and stable in the bank account. And it is. But from a wealth generation standpoint, it is not, it’s losing purchasing power over time. Stocks, common stocks, over time have been the simplest, most efficient growth vehicles to outpace inflation, and help grow your net worth.

Investments: True Passive Income

When I say efficient, and simple, I mean, it. Whoever came up with the phrase passive income as it relates to real estate was a marketing genius and a liar, but a marketing genius because the idea of residential rental real estate is anything but passive income. You have to work at residential real estate in order to get somebody to pay your rent. You have to market the property. You have to fix up the property. You have to fix the electrical, the HVAC. You have to interview the tenant. You have to do a background check. You have to go and collect the check when they don’t pay on time. You have to send them a follow up letter if they keep not paying you. Then you’ve got to send it to debt collection, or you have to have them evicted. And then you have to go in and clean the property after somebody else moves in. You have to fix it up and put in a new carpet and paint and other expenses. That is the least passive form of income I can probably think of. Whereas, comparatively, from the comfort of your own home, in your living room on the couch on a laptop, you could hit a few mouse clicks. And in less than a minute, you could make an investment in a diversified mutual fund or exchange traded fund and sit back and not check on it in 10 years, and the probability is almost 100% that you will have more money 10 years into the future than you do on the day you make that investment now. That’s passive without doing a single other thing. Now that’s passive income so I kind of digress on that.

But I guess I always get fired up about the how, when people think that investing is so complicated and hard. It’s because they make it complicated and hard. It’s not as hard and complicated as they make it. And certainly one of the most efficient ways of investing compared to other sources.

How Investing Works

We’re talking about investing, why we do it, how it works. So we’ve established that it’s one of investing in US common stocks, one of the simplest, most efficient ways of generating positive growth in your investments and enhancing and increasing your net worth. I want to clear up a misconception though, about investing and get down into the details a little bit. A lot of times, we talk about being in the market, or we invest in the market. And I think to the novice investor, that is a disservice because they think of the market as this uncontrollable, wild black box that is subject to unpredictable, short term gyrations. And it is, well, at least it is subject to gyrations, but it’s not a black box.

And the thing is, we don’t really invest in the market. The market at the New York Stock Exchange is a marketplace to exchange common stock. We don’t invest in the market. We invest in companies. Companies are what make up the market. And I know me and most everybody else who talks about investing talks about how the market did today or what the market did over the last year. That’s just the shorthand way of referring collectively to all the companies that make up the US stock market. But we don’t actually invest in a marketplace. We invest in the companies that make up the marketplace. And whether you invest in the companies directly, in their own shares of common stock (like you buy shares of Apple or Walmart or Intel), or you invest in shares of the company through a vehicle like a mutual fund, or an exchange traded fund and ETF, each of which are baskets that hold anywhere between sometimes as low as 25 stocks, sometimes as high as 5000 stocks in one mutual fund or ETF, you are investing through them into companies. And companies are run by professional managers. Professional managers who can be nimble, adaptable, resilient, motivated, and incented to produce profit.

So this is why we invest in companies because companies that produce goods and services that we all value that we are willing to pay for also turn a profit. And the fact that they turn a profit is valuable to the owners of the company. It makes the share prices increase. It allows the company, if they’re so inclined, to pay dividends. Which is like interest in a bank account. But it’s not quite as regular and it’s subject to the approval of the Board of Directors. But dividends and increases in value of common stock and that’s how we grow net worth.

So while the marketplace can seem like an uncontrolled black box, what is really happening under the surface is the value of the companies that make up the market. Companies are run by people and human beings. You work for a company, you may work for a large, publicly traded company that has reporting requirements and shares are traded on the US stock exchange. You are part of the mechanism that provides goods or services to your fellow Americans in exchange for payment. And ultimately, hopefully, you get paid the salary as do all your other coworkers. And if there’s some money left over, it’s called profit. And that profit is exceptionally valuable to the owners of the company. That is why you want to own shares in a company. Why you want to be an owner of a company. And I get really frustrated when I see people railing against the evils of capitalism, and how unfair it is that that the 1%, the high income earners have so much money. And corporations are evil, and Amazon doesn’t pay a fair wage, and all these things about why companies are bad, are riddled throughout the media.

But rarely do people talk about all the good things that companies do. If you object to Jeff Bezos’ wealth, or Elon Musk’s wealth, then I say don’t fight them, join them. They got wealthy by building and creating a company that produced something of value that people are willing to pay for. That then generates a profit for their companies, of which they are large owners. They own millions of shares in their companies. And as they create profit for their companies, it increases the value of those companies, and they get very rich. Well, so can you become an owner of the company, buy shares of Amazon, buy shares of Tesla, or better yet, buy a mutual fund. Most individual investors buy mutual funds or exchange traded funds, that they themselves hold shares of those companies that are profitable, and that produce a dividend. That grows their profit over time.

You can piggyback on that success. You don’t have to rail against it and fight against it and be jealous of it. You can participate in it. A rising tide lifts all boats. So if you don’t like the fact that Walmart, the heirs to the Walmart fortune have billions of dollars of net worth, if you really want to fight the system, don’t shop at Walmart. Because every time you do, you’re just giving more money to that organization. You want to boycott the companies that are producing wealth. That’s how you can fight them instead of being out in the streets in a picket line or something like that. But beyond that, you’re only hurting yourself long term. You have an opportunity to get good products at a low price at Walmart. And you can also be an investor in the company. And as they turn a profit, the shares in the company grow. And you grow your net worth by being an owner of Walmart.

One of the greatest wealth creation vehicles in human history – fractional shares of ownership of large public companies. It allows all of us to share in the success of successful companies. And we can do so in the modern era now, for almost no costs. And for very little effort. Like I said, from the comfort of your own home, from your couch on a laptop, you can buy 10 shares of Amazon tomorrow starting at 930 when the market opens and through a major brokerage corporation like Schwab or TD Ameritrade or Fidelity or Vanguard, or something like that. Transactional costs nowadays are almost nothing, maybe a few pennies, and you are an owner of a major US corporation and are able to share in that corporate instant success.

Mechanics Of Why Investing Is A Proven Long-Term Growth Strategy

Tonight we are talking about investing. Why we do it and how it works. And we’re getting down into some of the weeds on how common stock works, how companies produce profit, why that profit is valuable. And why do we feel so certain that long term growth rates of common stocks is so solid. These are under law. It’s not just a blind faith, or wishful thinking that stocks will average 10% per year for the foreseeable future. Even though they have done pretty close to that over the last 100 years. And of course, let’s just caveat that averaging 10% per year does not mean you get 10% every year. Of course some years, you get negative 10%, maybe even negative 20% or more. That happened in 2022. When our low point of the year was about minus 25% from peak to trough. That relative short term volatility, we call those temporary, always temporary. Declines are part of the price that we have to pay in order to enjoy higher long run rates of return on average, like 10%. And people who don’t understand that those market pull backs are always occasional and temporary and fear them irrationally. Those are the ones who make the big mistakes.

Why Investing Is A Proven Long-Term Growth Strategy: The Productivity Of The American People

So the reason why stocks go up long term is because they generally follow the earnings of the companies that make up the stock market. And so yes, what mechanically makes that happen? Well, number one the productivity of the American people. A country, our size makes up about 4% of the population. Yet we produce 24% of the global gross domestic product. Four percent of the population. We produce almost a quarter of the world’s goods and services. That is a highly productive workforce. I know it doesn’t feel like it sometimes. Especially when you’re waiting in line at the coffee shop. But overall, we are one of the most productive workforces, highly educated, hardest working, most industrious workforces on the planet. And that is what helps make one of the factors that go into helping make companies more profitable.

Why Investing Is A Proven Long-Term Growth Strategy: US Population Growth

Some other factors that are long term drivers of corporate profitability are the fact that US population has grown by more than half over the last about 50 years. We went from 210 million to 333 million citizens. So more people means more things to produce, more goods and services to be bought, more money exchanged hands, more profitability through the years. Including the productivity of the American worker, as measured against the per capita productivity. As measured against GDP (gross domestic product), rose from $26,000, to $60,000. So over a doubling of the productivity of the American worker.

Why Investing Is A Proven Long-Term Growth Strategy: Diversified Stocks Vs Individual Shares

Now, I will concede, you buy individual shares of an individual company, there is more risk at play there. A company can go out of business, which means its stock will go to zero. Stay there, and you’ve permanently lost that money. And that’s why, in our practice, we intentionally choose to in the majority of circumstances, use low cost exchange traded funds and some actively managed mutual funds for our clients in order to grow their net worth. It’s because we take that risk of a company going out of business and a client losing a significant portion of their investment right off the table. When you invest in individual companies, that risk is present and something to be concerned about. And so we have an upward trending vehicle, the profitability of US corporations, that is reflected in upward trending stock prices, all you have to do is get on the train and ride for an extended period of time.

Why Investing Is A Proven Long-Term Growth Strategy: Innovation By The American Workforce

And most importantly, earnings growth is propelled by innovation, new discoveries in processes, technologies, systems, materials, drugs, widgets, cars. We are constantly striving for income, incremental progress. We are constantly innovating, trying to do things better, faster, cheaper, easier, more than any other culture. It’s kind of ingrained in who we are. It’s part of the American DNA to always adapt and overcome and find a better way. And all those things come together to erve as the fuel for US corporations to continue their strong and steady march of increased profitability, increased earnings. Over time, those earnings get shared with the owners of the company, through either dividend payments for companies that pay dividends, or it helps increase the value of the stock. It causes the stock price to go up, you know, in the short term.

Why Stocks Go Up

Why does the stock go up? On a daily basis about the only reason you can give on why stock why stocks go up is that there were more buyers and sellers. On a daily or a short term basis, there were more buyers and the sellers, you can’t really say why 90% of time, there’s no real main reason other than there were more buyers and sellers. Same is true. Why did the stock go down today? Well, there were more sellers than buyers that supply and demand is what causes the price to move on a stock on an intraday basis. But long term, these are the factors of what causes company profitability, to be sustained, continue to grow, and profitability to increase and the stock price to grow. And it’s why we want to purchase the shares of those companies. Because we want to piggyback on that success. And that allows us, as individuals, to grow our net worth as well.

How To React To Stock Market Declines

So, when you start to know all these factors that come into play, when there is the inevitable, occasional temporary decline in the price of a diversified mutual fund or an exchange traded fund. Then your best response is no response. You don’t sell when your basket of well diversified high, well managed, profitable companies declined in value, because other people want to sell them. Well, perhaps, because through economic activity, profitability has been decreased, that can be a valid reason. But you don’t sell. That’s the absolute right time to want to buy more of the diversified mutual fund or exchange traded fund.

And be prepared to ride through the temporary occasional pullbacks in market performance. Those are not something to fear. If you are an accumulator, they are something to embrace. In those times of market pullback, if you are contributing to your company retirement plan, like 401K, TSP, 403B, you are buying more shares at a lower price with each contribution you make with your paycheck. It is where the money gets made. Because when the inevitable recovery occurs, you have just accumulated more shares than you otherwise would at higher prices, and your net worth grows faster.

But if you do the opposite, and you panic, or you don’t understand why the market is declining. And all you see is your balance decline in your 401K or your brokerage account. And you see the numbers going down and you want to stop the pain, then you are likely to sell at a loss or sell after a decline. Then you lock in those losses. You move the money to the bank account, and you don’t enjoy the inevitable recovery that eventually comes. And you don’t grow your net worth as fast as somebody who does otherwise. In fact, you might not grow your net worth at all. And we’re all free to do with our own money, what we want to do. And you’re all free to live the type of lifestyle that you want to live.

How Investing With A Long-Term Plan Helps Meet Financial Goals

But most people in this country are striving for something. Striving for a better quality of life, a better standard of living. And that takes money to accomplish. So if you want to have more money, if you want to grow your net worth, if you want to increase your wealth, then using the stock market properly, investing wisely, investing more through the downturns, when they occur or continuing to invest through the downturns is what will allow you to grow your net worth faster. And having more net worth means more wealth, means more money, means more options, more freedom, more power, in a good sense, more control over your life. And eventually, at some point you can get yourself to the point where you are what we call independently wealthy. You can maintain your lifestyle, your desired lifestyle, without income from any other source, but yourself. But your hard work that you’ve done up to this point through the discipline and savings that you’ve done up to this point, to the investments that you made up to that point in life. And eventually you get to the point many times where we get our clients to the point where they no longer have to work for a paycheck. They have enough money to sustain their standard of living for the rest of their lives with a high degree of probability already because of all the smart lifestyle and investment choices they made along the way, and it’s a liberating, powerful, joyous type of feeling. A calm, confident feeling to go through the rest of your life with that type of financial freedom. And that’s why we invest.

Keep Your Eyes On Your Long-Term Investment Goals

Remember what I was saying before the break about how a lot of people get their investing wrong, and they don’t stay invested through the occasional temporary downturns. They get scared in to selling by the rest of the media. The financial news media doesn’t help with this. CNBC does not help with this. CNBC, I like to say, is hazardous to your wealth. It causes people to make bad decisions. There’s a host of financial products that are in the marketplace that are designed to make you feel better about your investing and try to limit the occasional temporary downsides. But they also limit the upside as well to your investment plan. And they usually tend to be complex, expensive, and really unnecessary in the whole investing process. A lot of good long term investing is goal focused, and plan driven, which is counterintuitive for most people. You don’t build investment policy out of stock tips from your coworker at the watercooler or your brother in law, or watching CNBC for three hours a day or scouring the internet. That is not investment policy.

Steer Clear Of The Crisis Of The Day

And if you don’t have a good solid investment plan or policy, get aligned with a professional who does. It doesn’t have to be us at Wealthway Financial Advisors. There are plenty of other people here in the Hampton Roads marketplace that do work similar to us. But we do have proprietary investment processes that we’re pretty darn proud of. There are other professionals that can help systematize your investment process and, if nothing else, that can go a long way to help you improve your investment performance. Because one of the things we always say in the industry is there’s always a crisis of the day. There’s always an excuse to get out of the market. There’s always a reason to be fearful of what’s going to happen with your money if you don’t have a plan. Right? It wasn’t too long ago, when all the all the news was talking about a potential recession. Have we had one? Nope, hasn’t occurred. But boy, everyone was scared about it. All over the news about the banking crisis. Remember, Silicon Valley Bank? And there was another one. They went out of business, went defunct, the whole banking system was going to collapse. Didn’t happen. Now, here we are still. The banking system is strong. I’ve heard inflation, runaway inflation, unprecedent. Haven’t seen it in a decade. Well, okay. It’s high. It’s elevated. Inflation right now is around 6%. But it’s declining from where I think it’s actually 5% but declining from its peak of about 8%, several months ago. Elevated, but declining and returning, regressing, closer to its historical norm. So all these crises of the day work against you to try to scare you out of the market out of the greatest, simplest, most efficient, and least expensive, wealth generating vehicle that mankind has created. All of those things are working against you. If you don’t have the temperament to be an investor, then you probably should not be an investor because you are likely to do the wrong thing at the wrong time and harm yourself more than if you just didn’t try to invest in in the first place.

Only 50% Of Americans Have Invested In Stocks

And interesting stat, at least it’s interesting to me, I found this number to be rather low – only about half the people in the United States in some form or fashion, own common stocks, own equities, whether it’s outright shares of a company or through a mutual fund or ETF. Most people own them through their company retirement plan 401K, 403B, TSP. You own stocks if you invest in those plans. But only 50% of the country is even invested in one of the greatest wealth creation vehicles of all time. We’re here to help. But you’ve got to help yourself at the same time.

Objective, Unbiased Financial Advice from Local Financial Planners

We are an independent registered investment advisor firm, which means we’re legally held to a fiduciary standard to put our client’s interests ahead of our own in any business dealing. And that’s the way it should be when you work with a financial advisor. As the premier financial planning firm in Hampton Roads, our team of Certified Financial Planners® integrate expert investment management with customized ongoing financial planning advice to help our clients analyze big financial questions and enhance their quality of life.

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