Why do you invest?

A few people may stumble into financial security. But for most people, the only way to attain financial security is to save and invest over a long period of time. You just need to have your money work for you. That’s investing.

Simply put, you want to invest in order to create wealth. It’s relatively painless, and the rewards are plentiful. By investing in the stock market, you’ll have a lot more money for things like retirement, education, recreation — or you could pass on your riches to the next generation so that you become your family’s Most Cherished Ancestor. Whether you’re starting from scratch or have a few thousand dollars saved, Investing Basics will help get you going on the road to financial (and Foolish!) well-being.

Now that the markets are showing signs of life, the pundits and financial writers are pumping out investing articles of all kinds. Gold is prominently mentioned as are a wide variety of stocks, mutual funds, and exotic ETFs. More so than ever, when I read these articles I ask myself this question: Why should I invest in that? Or taken one step further, the question becomes: Why do I invest?

I actually struggled for a long time on how to open up this post, but taking a page from Finding Forrester, sometimes it is easier to let someone else write the intro for you.

It should come as no surprise that many folks have asked the age old question of, “why?”.  In fact, everything that I say in this entry, has likely been written in greater detail, depth, and clarity, by someone else.  However, it is a necessary step in my overall roadmap of investing.

So, the question as it stands, why do you invest?  And as an extension to that, how do you know that you did it well?

The three quotes cited above contain a wealth of information on the how and why of investing.  At the end of the day, If we ignore the mechanics of investing (e.g. compound interest, “buy low, sell high”, “long time horizons”, etc.), the reason that any of of invest is a deeply personal one.  However, in my view the reasons for investing can be broken down into one of three categories:

  1. We invest for personal gain
  2. We invest to achieve some target and/or goal
  3. We invest for someone else

Fundamentally, these three reasons cover pretty much every scenario.  Saving for retirement?  That is #1 or #2.  Helping a relative?  That is #3.  Saving for school?  #2.

The reason that I have broken everything down into three categories, is that the why of investing is useless without some type of barometer as to how well you are investing . If you are saving for school, you know if you are successful if you have enough for your tuition.  If you are saving for retirement, then you have enough if you know that you can be financially secure after you stop working.  If you are saving for personal gain (e.g., “I just want to be rich”), you are successful if the personal decisions you make in your investing are better than those that would be made if you paid someone else to handle your money (e.g. a financial advisor).

There are really only two ways to monitor your performance: absolute, and relative.  In absolute measurements, you have some fixed, quantifiable goal against which you are measuring yourself.  If you are saving for your child’s education, and you know that the total cost will be $50,000 with tuition, books, and residence fees, then you have an absolute target against which to work.  Contrasting this are relative measurements.  These measurements are typically against some benchmark, and fundamentally reflect the opportunity cost of investing relative to some other means.  For example, if your benchmark is one of the couch potato portfolios, the performance of your investment decisions shows how much better (worse) you have done by managing your own money, instead of following the couch potato formula.

With the above in mind, the question should not be “Why do I invest?”.  Rather, it should be, “Am I meeting my investment goal?”  Defining your investment goal will lay the foundation on which you base all of your future decisions.

-10d



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