Two words normally used interchangeably – saving and investing – should not be considered synonymous. The primary concern of saving is safety. The primary concern of investing is growth.
Okay. I admit it. This is an idiomatic distinction. Look at most dictionaries and you will see saving and investing listed as synonyms.
But there is a difference. And it’s dangerous to consider every sort of thing that you do with money as investing.
Dangerous and convenient. It allows you to rationalise that vintage Mercedes as a sensible investment rather than an expensive toy. It has allowed me to rationalise the purchase of works of art from new and “emerging” artists as long-term investments like the oil paintings I have by Jean Derain and Diego Rivera and Edouard Vuillard.
The point is that there are all sorts of asset classes, and each one has its own characteristics. Some are very good for safety but not so good in terms of value appreciation. Some are great at providing income but only in the short term. Some have the potential of becoming enormously more valuable but come with a high risk of failure.
The assets you buy, therefore, should be seen as very particular assets bought for very particular purposes.
I’ve arbitrarily defined saving as the collection of assets that have very low or no risk of capital depreciation, and investing as the collection of assets that have a strong potential for equity growth. But basing the distinction between saving and investing on the purpose of the assets you buy is problematic. Because it’s not just a matter of purpose but also of risk and time.
The purpose of an asset is self-evident. It could be for retirement or the kids’ college or aluminum siding or a vacation in Hawaii.
Time – the time between when you buy and when you intend to sell – is also easy. If the asset is earmarked for retirement, it could be 40 years. If it’s for the kids’ education, it depends on how old the kids are. If it’s for next year’s vacation, it can’t be more than 12 months.
Risk is a bit more complex. In this context, it refers to the odds that the value of the asset will have diminished or disappeared by the time you intend to cash it in.
For many reasons (and this is a subject for another discussion), I have never been able to rationalise taking a lot of financial risk. My goal is always to be confident that when I want to cash in an asset, it will have the value I expect it to have.
If you take that point of view, you will never buy high-risk investments. They simply won’t be in your portfolio. (Although you might buy some as a form of entertainment, which is spending, not investing. But this, too, is a subject for another discussion.)
What will matter is volatility.
All of your investments will be low- or no-risk, but they will differ in terms of volatility. Some will be volatile in the long run but safe over longer stretches of time. Others will have very little volatility at all.
Imagine three boxes.
- In one box, you would have assets with low short-term volatility and long duration.
- In another, you would have assets with low short-term volatility and short duration.
- In a third, you would have assets with high short-term volatility and long duration.
And that would be it.
Let’s say you are 28 years old and want to put money aside for retirement. In this case, you are in the long-duration game. And this means that you can create a portfolio that has both high and low short-term volatility, but no long-term volatility.
Many financial advisors have a different perspective. They say that when you have a long-term perspective, it is perfectly acceptable to buy investments with long-term volatility. They say it is safe to invest in such risky assets because you have so much time to correct mistakes.
But the data show that these advisors are wrong. When your investment perspective is 30 or 40 years, you would do better to avoid long-term risk by eschewing assets with long-term volatility. A portfolio of high and low short-term volatility assets is best. (If you apply this to stocks, it would mean investing in, for example, no-load index funds.)
If you are 28 and are putting aside money for your twin 10-year-olds’ college, your time perspective is seven or eight years. So in this case, you would want investments with low medium-term volatility.
And if your goal is to pay for a Hawaiian vacation 12 months from now, you’d want assets with low short-term volatility.
That is my investing strategy, and it has worked well for me over the years. By avoiding risk and recognising purpose, time, and volatility, I’ve never come up short in terms of completing my financial objectives. I’ve been able to set and then achieve realistic goals.
If you would like to learn more about how I have saved, invested and built my millions over the years, check out my new club here.
Now let’s talk about my saving strategy…
I find it easier to be consistent with my investing strategy if I keep separate accounts for my short-, medium-, and long-term purposes. So, for example, I keep separate accounts into which I deposit money that I will have to pay out in a short amount of time.
One of those accounts is for money I will have to pay to the IRS (tax). The account is in my name. But as far as I’m concerned, the IRS owns it.
Let’s say I get a cheque for $10,000 (or $100,000 or $1 million) as payment for consulting work. I know that the IRS will eventually claim 40% of it.
I can bitch about it. I can try various ways to put it off. But after 40 years of being in and around the tax-minimisation business, I know that, ultimately, $400 out of every $1000 I earn is not mine to keep.
Since that $400 is not mine to keep, I don’t want to fool around with it. I don’t want to invest it, because when you invest, there is always a chance that you’ll lose some or all of the principle. And my aversion to losing some or all of money that is not mine is much greater than my interest in increasing it.
So I save it.
You may feel differently. And that’s fine. My point here is to illustrate why, whenever I take in taxable income, I immediately put the tax I’ll owe on it into a separate, super-safe bank account that is off limits to me.
In my mind, it is money that is already gone. And unlike money that I am investing for medium- or long-term growth, my only goal for it is to keep it from losing value.
Notes From My Journal: Stress – think of it this way
Scene: Seminar on stress management, meeting room at The Ritz on Central Park
A young lady walks around the room holding up a glass of water.
“What am I going to ask?” she says.
All hands go up immediately. She picks one.
“Whether the glass is half full or half empty.”
She smiles. “Actually, I want to know how heavy this glass of water is.”
Answers called out range from 8 oz. to 20 oz.
She smiles again.
“So what’s the answer?” several ask.
“The actual weight isn’t the point,” she says. “What matters is how long I hold it. If I hold it for a minute, that’s not a problem. If I hold it for an hour, I’ll have an ache in my right arm. If I hold it for a day, you’ll have to call an ambulance. In each case, it’s the same weight. But the longer I hold it, the heavier it becomes.”
The lesson: Put your burdens down for a while. Give yourself a rest. Practice the resting, not the holding.
Today’s Word: transmogrify (verb)
To transmogrify (trans-MAH-grih-fie) is to transform in a surprising or magical manner. As used by Ayelet Waldman: “As a novelist, I mined my history, my family, and my memory, but in a very specific way. Writing fiction, I never made use of experiences immediately as they happened. I needed to let things fester in my memory, mature and transmogrify into something meaningful.”
The first cellphone was invented in 1924.