investing, money management, and personal finance beginner's guide
At. A surface level the concept, of investment, is easy to grasp an investment. Is a purchase, you make hoping. To get a profit later on down the road that's easy to understand, but. There, are also several components. To an investment. Specifically. Time, capital. And profitability. Time. Is the period that you should expect to hold an investment, you. Might have heard this referred to as the time horizon. Time. Horizon, can last from seconds, for day traders to, years, for those taking a long term approach, the. Time horizon you have is purely, dependent, on your situation and, your, risk tolerance, for. Example if you're a 70, year old retiree your, time horizon and risk tolerance are going to be much lower than a 24, year old who's just entered the workforce. The. Rationale, for that is that market trends shift over time but, ultimately if, you hold the investment, long enough it'll, payout profitably. As you. Can imagine our retiree, has a much shorter time window, and doesn't, want to see short-term, losses as the money might be needed sooner a, younger. Individual, can, wait out market, forces to liquidate, later on and still, see profit, of course, age isn't. The only reason one may have a short time horizon, the. Second component is capital. That's, essentially, the financial, value of assets you can think of it as monetary funds it, can also refer to tangible, items such as plant property. And equipment that's. Pretty easy right the, only caveat is, that in order to be categorized, as capital, the goods or money have to continuously. Provide a service to the business whether. That's paying salaries, or purchasing. Assets to create value so, how, does this fit in with the investment, component well, when you invest you're making capital, investment, you're. Helping a company or product, reach, its business, goals like giving it money last, but definitely not least we, have profitability. A quick. Definition, of the term answers, the question how, much money am I going to make most, people would say this is the most important, part of an investment before. You invest in a business or goods, or people you. Have to ask yourself if the investment, will result in a profit, always. Optimize, your investment, to have the highest ROI or, return on. Investment. Possible. Again, only. Three basic components, but, investing, is a lot more nuanced, however. Keep in mind if, you're. Making business, decisions regarding, investment, be, sure to think about how much time the investment needs to see a return how, much capital you're going to use in the investment, that you could potentially use for other things and, what. Kind of profit you expect to see when you get the return. You. Alright, you get it investments. Can be a good thing especially when. You get a good return but. How do you know when you're ready to invest if we're. Talking about personal finance then. Maybe it has to do with how much risk you're willing to take if you're. Willing to invest money you, also have to be willing to lose it it's a gamble and the future is quite difficult to predict, however. If historical. Data hold up then, you'll end up ahead if you, hold on to the investment, long enough regardless. Of market fluctuation, so, how. Do you know when you're ready to make business, investments, well. If your, business is growing at a fast rate and you can't support it with your current infrastructure, you've got to start spending some money this. May include plant, property and equipment hiring. Extra staff or buying. More inventory, but. Keep, in mind that this is all a balancing, act in order. To finance these extra purchases you'll, more than likely be taking out loans at a certain percentage or giving. Out equity so. Your, return percentage must. Be greater than the interest that you're paying the bank in the long run let's. Be real even, without any math you can intuitively figure, out what investments, may be best for your business you. Don't need to buy a Ferrari, as a company, car, likewise. You probably shouldn't invest all your liquid, in a volatile, cryptocurrency, because. You're following that's. The fear of missing out, you. Have to diversify, your investment, portfolio seek. Long-term returns and do, the math on potential, profitability, for, each long term investment, I know sounds, intimidating right, something.
Else You have to consider are your liquid assets all. Businesses. Want the highest return on their dime this. Is impossible, given, the timing of expenditures, and costs. That being, the case businesses. Should maintain economic capital. Economic. Capital is all the money that's kept in banks spare, cash or anything, else that may be liquidated, immediately. For cash requirements. So. Any money, kept an economic, capital should, not be invested, you, may be tempted to invest more money than is prudent to maximize. Rate of returns but, that's just a temptation, that you have to avoid. Inventory, includes all the assets that are going to be sales including. Finished. Products works, in progress and, raw. Materials, work. In progress items, have, been started, but aren't yet completed and raw, materials, are those that haven't even begun to be processed, a lot of, liquid can go into raw materials, you, really, don't want to overspend on inventory, as they'll, eat up funds think. About it the actual inventory costs money and you, have to pay to store it somewhere and we're. All kind of guilty on this on some level right I know, that I always by way too many groceries in anticipation, of upcoming weeks and watch, half the stuff go bad in my fridge in this. Course I'll show you a technique called NPV. Or net, present value, that, can help you determine how to best increase, your return on inventory. That. Way your business can free up liquid assets to generate returns, and, also. Reduce opportunity, costs, associated. With liquid so. The big, takeaways, from this video are you, should start investing, more if your business needs it don't, wait around for, your infrastructure, to crumble seek. Out loans or other support, also. Don't. Burn through your economic, capital for the sake of investing, you, may need that cash for emergency, situations, most. Commonly for people these reasons are tax related finally. Think about your inventory, don't. Buy up too much before you need it you'll burn through cash and you'll have to pay to storage somewhere do the math to make sure you don't burden yourself in, the future. You. So. You have some money that you can invest the, inventory, is taken care of you've built up some economic, capital for a rainy day and you're, ready to scale up your business well. There are definitely things you can invest in first. And foremost think of plant property, and equipment or PPE, these. Are items that help you in production, maybe. It's a more efficient, tractor, that breaks down less or more. Powerful boosters, for your SpaceX, rocket, any. Improvement. That will increase production rate and attract. Investors, is a worthwhile investment, super. Profitable, however. Keep. In mind that assets, generally, lose value, over time so. You won't be able to sell an asset at the same price you bought it for, you. Can also buy real estate especially. If you're looking to expand services, locations. Or inventory, I, love. Real estate it's. One of the only assets, that appreciates. Over time, so, you can hold on to it milk, it for a home equity line of credit or as, a rental property and then sell it for higher than what you bought it for there. Are of course exceptions to, all this I know, we still all cringe when thinking about that crash in the late 2000s. You. Can also buy stock these, are literally, certificates, that say you own a portion of a company when. You buy stock you, have a right to a portion of the company's value, or right. To carry out a specific action. Usually. Companies. With excess, capital or liquid will try to buy back shares of, their own company, to control the board or have, majority shareholder, of the stock. Generally. Speaking stock. Shares tend to increase in value over time and are considered, a decent, long-term investment. You. Can also invest in projects, projects. That can help your business grow that's, going to be the real focus this course buy. Projects. I mean, deals they'll make your business money whether. It's a construction job where you're renovating buildings or, a job, where you're doing people's tax returns these. Are the services that will make your business money, projects. Require a lot, of overhead in terms of labor supplies. And most, importantly, time, and oftentimes, your client, won't pay you until, the projects even though so.
You're Basically working on borrowed time and, at, a profit loss so. You have to ascertain, ROI before. Moving forward with the project or at, least get a handle on what kind of profit, you'll be looking to make. What. I have provided is not an exhaustive list by any means but, I also want to get to the point my, goal is to show you different. Ways to think about your projects, and how to get the most bang for your buck for, your effort and for. Your time. You. The, topic, of this video is opportunity. Cost, think, about that phrase yeah. Opportunities. Will cost you something and maybe, you're thinking this, instructor is crazy, opportunities. Simply require hard work yeah. That's right many of them do and they, also require something, way, more costly, your, time if I. Can get you to come out with just one key understanding, or take away from this course it's, this your. Time is the most valuable asset. That you have when. You're evaluating, what, to spend your money on always, keep the idea of time in the forefront why. Because. You'll have to give up time to achieve your goal or realize. The investment, that you're putting your money into the. Opportunity, cost is easy to swallow if you, like low-risk, scenarios, and if. The alternative, investment, involves. Volatility, for, example with the stock market so. Here's my point whenever, you're presented with two reasonable, options, the, choice is never clear-cut, you, have to examine the opportunity, cost to, determine the best possible outcome, for your investment, and that investment, can, be time money. Or both. You. Y'all. Let's, face, it time. Is money. I think, so, highly, if that cliche, turn a phrase you. Don't have to be an extremist, like me but, you should definitely understand. The idea behind, the, time value of money when. It comes to investment, know. That money that you currently have is worth, more than the same amount of money in the future in so. Many ways the, biggest, loss of money you'll incur is due, to loss of time why, well, because if you don't put your money to work it's. Just gonna sit there it's gonna cost you big people, corporations, big, banks they all want your money and they're, willing to pay you to borrow it let's, take a minute now to think about the concept of the time value of money one, of the reasons it's so important, to calculate free, cash flows is on a dollar received today is worth, more than a dollar received, a year from now why. Would that be well there are a few reasons first. Opportunity. Cost a dollar, received, today can, be invested, in other projects, that'll make more money if the, dollar isn't receive, until a later date the potential, return on investment, is forfeited, next.
Most Economies. Experienced. Inflation meaning. That the purchasing, power of its currency is diminishing, over time what, a dollar can buy today is much. Less than what it could save 50, years ago finally. The dollar received, in the future is less certain the. More time between now and when, the dollar will be received the, more likely, it is that something will happen that will result in the dollar not being transferred for, example, the person who owes you the dollar could go bankrupt or you know just change, his mind about paying you back so. You better get that money as quickly as you can simply. Put there's more value associated with the dollar being received sooner, let, me give you a classic example, would you be interested in getting a thousand dollars now or, the, promise of a thousand dollars a year from now well, I guess if you're looking to purchase that new big-screen TV, then you want it right now but. What if you're looking to invest it well you still want it right now let's, say you take that money and invest in the bond that pays 5%, annual interest one. Year from now you'd have, $1,050. That's a $50, increase and you, didn't have to do anything to earn it except, loan your money to someone else and accept, the risk that they may not pay you back but, what happens if instead of receiving that thousand dollars today you received a promise that you would get those thousand dollars one year from now in, this situation you'd, find yourself forfeiting. The $50.00 you could have earned if you had the money sooner and you would still face the risk of not being paid a thousand dollars you're being promised I guess. You can make the argument that if interest rates increase the. Bond would decrease in value and then you have to deal with the market volatility and all that stress but, that's a different story all together time. In the market, is far, superior to. Timing, the market and don't you forget it this, scenario, also brings about some terminology that's, quite useful the. Thousand dollars you get now it, has a nominal, value of a thousand dollars that's its face, value the, real value, given, the 5%, interest growth a year from now is. $1,050. The, real value will increase if the discount, rate which is just another term for interest stay, steady at 5% year over year let, me teach you a fun trick to illustrate, the power of time it's, called a rule of 72, the, rule basically says to divide 72, by the interest, rate that determine, how long it takes you to double, your principal, it's, not exact but it gives you a good approximation so. If we have a 5%, interest rate and our $1,000. We, would have about $2,000, in 14.4. Years and that's, just on a simple bond imagine. If you have an average return of 8%, in the stock market on even more money even, with just $1,000. You double, it in nine years so. Would, you rather have $1,000, now or, the, promise of $2,000. Nine years from now that. Average, return is not, promised, and markets, can be volatile, but. Historically, speaking your, investment, will appreciate in the market over the long term and that's. What everyone counts on when, they invest. You. Before. We get going with the heavy hitting techniques, I will say this there. Are many ways to evaluate, in which direction you, should go with an investment in this, course I'm going to show you the most common ones that are industry standard and are. Fairly easy to apply in your own scenarios, if you. Don't own a business you should still be aware that these mathematical, and logical concepts. Apply, to your daily life as you. Continue following along you'll see what I mean here's. A sneak peek of what's to come in subsequent chapters. The. First technique, we'll cover is discounted, cash flows which I'll also call DCF, from time to time it. Basically just uses cash flow projections, and discounts. Them fairly. Analogous, to calculating, present value using a discount rate, although. The calculations, are complex the purpose of DCF analysis, is simply, to estimate, the money you'd receive from an investment and to, adjust for the time value of money if you. Already understand, the concept, of the time value of money you, can probably skip the chapter on DCF. Then. We'll build on DCF and look at net present value, commonly. Referred to as NPV. Net. Present value, is a difference, between the value of cash inflows, and the present value of cash outflows. Over, a period of time the. Result is a single, number that gives a good indication of what a business or a particular, investment is worth today. The. Discount rate that most companies use in the NPV calculation is, the weighted, average cost of capital or, whack, many.
Factors, Influence, the calculation, of the whack which, ultimately represents. The cost to the business of raising, funds if, a project or investment, can't earn a return of more than the whack the, business will be losing, money on the investment, the. Actual, calculation, of whack is beyond, a scope of this course but, it's important, to understand what the number represents. Well. Then jump from NPV, to IRR, known as the internal, rate of return the. IRR, is basically, the discount, rate that sets the NPV, equal to zero and, it, allows, us to see the percentage, rate that, will be earned for a given set of cash flows. Based. Off IRR, we can then look at the payback period which. Tells us how fast, the investors can have their money turn, in. Conjunction, all these, techniques can provide a really nice picture of whether, a project is worth investing, in now. That you have a basic, idea of how the course is structured let's, dig right into the specifics. You. The, estimates, that you get from DCF, are not, intended, to be a solid, number regardless. I really like DCF, why, well, first, and most importantly, it takes, into account the time value of money it's. A fairly sound valuation. Method, because. It relies on free cash flows it removes, subjective. Accounting, policies, that companies may have in place for example, there. May be arbitrary, rates and methods of depreciation for. Fixed assets or, accounting. For future return items. Creative. Accounting does exist, but using, cash flows tends, to attenuate the effect that being. Said there, are some downsides of DCF as well first. Of all it doesn't take into account the initial investment. That's made we'll. Get into that soon, second. It's very, sensitive, to assumptions, that are made by the analyst we, also assumed. A constant, growth of 2.5%, year, every year which, is probably not going to be the base for any kind of business so. Think. Of DCF, as a moving, target that changes, with company expectations, it's. Not the end-all, be-all but, it does a good job at, determining how much money you, should throw into, an investment. You. Net. Present value, or NPV is. One of the most valuable, decision-making. Metrics, you can use to, decide whether investment. Or project. Is worth, your time or money. NPV. Builds, off the concept, of discounted, cash flows here's. A fancy equation, with all its Greek symbols, and stuff however. If you strip that down and get to the root of it it's, basically, DCF. With, one extra component, the. Equation, says that you add up all the present values of all future cash inflows and then, subtract, the sum of the present value of all future cash outflows. These. Inflows, and outflows are, simply, revenues, and costs. What. Makes NPV, so special, is that you can continue, to calculate, npv over, the duration of a lifetime of a project, obviously. The, project's, NPV, is likely to decrease over time it has less life and fewer unrealized, cash flows because, it's all regenerated. That revenue for you. Look. At the two equations again for DCF, and NPV to. Reiterate, NPV. Is simply, DCF, less, the initial cash investment. Keep. This one takeaway in mind that differentiates, between these, techniques. DCF. Tells, you the present, value of the cash flows expected, from your model, basically. The ongoing, cash flow to be generated, from your investment. NPV. Tells, you the net return after. The accounting, of overhead. Cost. So. If the NPV, for a project is positive, that's a good thing you want to take that investment, or project, if it's, negative you probably, shouldn't take on that project because you're more than likely going to lose money I'm, putting air quotes around lose money because of opportunity cost, if the, NPV, on a project is negative, you're, more than likely going to get more money out of a project that has a higher NPV or from.
Something Like a stock market on average, any. Investment. Will produce a negative NPV if the applied discount, rate is high enough so. It makes sense to double-check, the estimated, costs, to look for opportunities, to economize to. Review the sources of revenue to seek, the central enhancements, and to, revisit, the assumed discount, rate, what. If the NPV is zero, remember, NPV. Is a measure of wealth creation relative. To the discount rate so, a negative or zero NPV, does not indicate no, value, rather. A zero, and PV means that the investment, earns are ready to return equal. To that of the discount rate if you. Discount cash flows using a 6%, discount rate and produce, a zero dollar NPV, then, the analysis, indicates, that your investment, would earn a 6%. Rate of return. You. I. Really. Like IRR, for its simplicity, at least, when the project investment structure is simple there. Are no difficult, formulas, and it gives a really good metric, that you can compare against other projects, that you're considering I also. Like it because it ignores a lot of the guessing, for, example, you don't have to worry about what the wack discount, rate is so. The, risk of calculating, it is immediately. Mitigated, of course. I also love that IRR, takes into account the time value of money which. Results, in each cashflow being given an equal weight, however. Its simplicity, also, limits, its scope for. Example there's no parameter, for the size of the project a project. With $100,000, overhead, cost and projected. Cash flows of $25,000, in the next five years has, an IRR of seven point nine four percent, whereas. A project, for the ten thousand dollar overhead, and project, the cash flows of three thousand in the next five years has, an IRR fifteen point two percent, using. The IR method, alone makes, the second, smaller, project, more attractive, and ignores. The fact that the larger, project can generate significantly. Higher cash flows and perhaps, larger profits. So. Every. Method comes with its pros and cons I find. It best to use NPV, and IRR, in, conjunction, to, make an evaluation. You.