Investing Basics

John Brennan and Rick Ciolino from Cape Ann Savings Bank talk with John Maher about investing basics. They discuss how inflation and compounding interest affect investments. Then, they look at the life stages of investing, when to start investing, and what to do before you start investing. Finally, they explain how to balance risk and reward.

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Transcription Disclosure: Below is a transcript of the conversation between John Maher, John T. Brennan and Rick Ciolino. Please note, this is an unedited "word for word" rendition of the actual conversation and is not intended to be grammatically correct.

John Maher: Hi, I am John Maher and I'm here today with John Brennan, Senior Vice President of Trust and Financial Services, and Rick Ciolino, Trust Investment Officer at Cape Ann Savings Bank in Gloucester, Massachusetts. Today our topic is investing basics. Welcome John and Rick.

John Brennan: Hi John.

Rick Ciolino: Hey John.

What Is Investing?

John Maher: So John Brennan why don't we start with you and just ask the simple question, which is, "what is investing?"

John Brennan: Well, John, we're all familiar with a piggy bank. We're all familiar with the notion of saving. We're putting a few coins into the bank or a savings account or something like that. And then if you think of speculating, where speculating would be putting money on a roulette wheel analogy, or the stock equivalent would be buying one particular stock, say Tesla, and hoping it was going to go up and it was going to go to the moon.

Investing is really a hybrid of these two things. It is a managed and prepared approach to managing and accumulating money, typically over a long time period. So investing is usually undergirded by some kind of plan, some kind of allocation between stocks and bonds, some kind of way to manage risk, and a timeline.

Life Stages of Investing

John Maher: Okay, and what are the life stages of investing? John Brennan: Well, we're born with a zero net worth, okay? You enter your childhood, you really probably are negative net worth because you're a liability to your parents, they can write you off on their tax return. And then when you prepare for the workforce, maybe you take on some debt, maybe you go to a trade school, maybe you go to college, maybe you do some other kind of act where you take on a little debt to learn a skill, and then you enter the workforce, you pay off that debt, and then you start to accumulate assets, hopefully.

So the accumulation stage of your life is when you hopefully zero out your debts. I'll exempt mortgages from that, but you zero out your debts and you start to add to your assets. You might add to your assets through saving, you might add to your assets through investing, and that period hopefully takes you up to your retirement.

And typically, once people start to retire, they enter the spending phase of their personal lifestyle, or their personal financial plan, and they start to decumulate and they start what I would call the distribution phase of their life, which hopefully takes them to before they die, in which case they might leave some assets to some loved ones or something like that. But that retirement distribution phase could take them... Who knows? They could wind up with a negative net worth by the time of their death.

But those are those, it's really three phases, the beginnings, the accumulation phase, and then retirement and distribution.

Effect of Inflation on Investments

John Maher: Okay. And what's the effect of inflation over time on your investment?

John Brennan: Rick, you want to take that one?

Rick Ciolino: Yeah, the interesting thing, we all understand inflation and we've seen it all more recently in the supermarket and just in daily life. And it's the same thing on the investment portfolio because as we're trying to grow our money for future use, inflation is a detractor.

So if you have $10,000 and you just want to put it in your mattress and hold that $10,000 for the future, well that's well and good. Although $10,000 in the future will be worth less than it is today because every year prices are rising through inflation. We might have years where prices rise quite a bit like last year, or there might be years where they don't rise as much, but on average over time, we can expect probably three to maybe four percent inflation over time.

John Maher: And so what effect does that then have on your investment? Does it just mean that you'd need to try to make sure that your investments are meeting or exceeding the inflation over time?

Rick Ciolino: Well, it certainly does. It depends on what your goals and what your needs are. But if your goal is to continue spending at the level that you're comfortable spending at, then as your investment manager, my goal is to try to help you to come up with ways that you're growing your money over time so you can spend more over time.

John Brennan: And you're outpacing that inflation number. That's the key.

John Maher: Right, if you're only meeting the inflation number, then you're just, whatever money you're putting into your investments, you're basically just keeping it the same if all you're doing is matching the inflation number over time.

John Brennan: And some investors just want to match inflation. They don't want to take on risk, so they just want to meet inflation, so they retain their spending power. But some investors have the missions to outpace inflation and grow their assets.

How Compounding Interest Affects Investments

John Maher: Okay. So John Brennan, what is compounding interest and how does that play a role in your investing?

John Brennan: So compounding interest is money that accumulates on your money, and then that accumulates again. So if you have a thousand dollars and there's a five percent interest rate, after year one you have $1,050, okay? So then in year two you have $1,050. Well, what's five percent of that? Well, it's a little bit more than fifty dollars. So that compounding is the effect of money accumulating on top of money and compounding each year as that asset base grows, the money on top of the money gains interest too.

So it is a powerful force because if you have time, money can compound on top of money, which is good for an investor. And it's the same principle in the inverse with debt; if you have a debt and it has an interest rate on it, and if you don't pay your credit card, what happens? The debt grows, the debt is compounding. So that's the inverse, but compounding interest is the positive side of that, and that's how it can help you in the investing sphere.

When Should You Start Investing?

John Maher: Okay. Rick, what does that mean in terms of when you should start investing?

Rick Ciolino: Well, what it means is the earlier you can start investing, the better. If you think about the ability for your money to grow and to lead to meet your goals, whether it be education in the future or whether it be retirement or whatnot, the earlier you start putting it away, the more your money will compound over time. We always recommend people start investing as soon as they can, whether it be through a 401K or through opening an IRA or whatever means they have. For example, if you start putting away a certain amount per year, that money as John mentioned, will grow every year on top of it. And the longer you can do that, the more you'll end up in the future and the more ability you'll have to meet your goals.

John Maher: A lot of employers offer matching 401K contributions. So if you start a 401K with your employer and then you put in a certain amount of money from your paycheck, the employer will match that amount and also put in that amount of money up to a certain amount. What are some of the benefits of matching 401k contributions from an employer?

John Brennan: The benefit there, John, is that's free money, okay? That is literally free money. So if your employer is matching three percent of your salary, you should at least save three percent of your salary because then you're really saving six percent of your salary. So going back to the prior question of when should you start and how should you start, at least get that match because that is a great way to start, and that's a tremendous benefit really to any employee.

Preparing for Investing

John Maher: What are some of the things that you should do before you start investing? Is there anything that you need to do in order to sort of prepare yourself for investing?

Rick Ciolino: What I think the most important thing that people should consider before they start investing is that they really need to understand what they're investing for and how they're going about it, and to develop a plan. For example, somebody may have some more short-term goals where they're trying to raise money for a new car, a house; could be an intermediate goal where they're looking to save enough money for college for their kids, or it could be something longer term when they're looking at retirement.

It could be in combination of all of these, but the most important thing is to have a plan so you understand what your goals are, what the possibilities are, and what your expectations are going in.

Risk Vs. Return in Investing

John Maher: And John Brennan, can you talk a little bit about risk versus return in terms of investing?

John Brennan: Sure. There's some logic to it. When you think in terms of risk, let's say there's a biotech company and all they have is an idea. They have an idea about how they can divide this cell and it can attack cancer, okay? So maybe they've got a very smart guy working for them, but they really have no plan and they have no concept, but there's a very smart guy.

So how does that come across? That comes across as pretty risky, okay? You don't have cash flows, you don't have patents, you don't have the science behind you, so that means you're delving into something risky.

Now, let's say you are a conservative investor and you invested in U.S. Government treasury bills. That is a low risk. The U.S. is very unlikely to default on its debt. You might get a more modest return on those investments, but they'll be much safer. Is there a little risk? Yes, but not nearly as much as a biotech startup or a technology startup or a strange inventor in China who's gathering money to make flying cars.

John Maher: Right so you have to weigh those risks versus the rewards, and that's going to be different for each person, right?

John Brennan: Exactly.

Contact Us to Learn More About Investing

John Maher: All right, well that's really great information. John and Rick, thanks again for speaking with me today.

John Brennan: Our pleasure, John.

John Maher: And for more information, you can contact Cape Ann Savings Trust and Financial Services at (978) 283-7079 or visit the website at capeannsavings.bank.

Investments purchased through the Cape Ann Savings Trust and Financial Services department are not FDIC insured, not FDIC guaranteed, not bank guaranteed, and may lose principal value.