Saving and investing always sound like things you know you’re supposed to do, but you’re not really sure why, and you really don’t know how. So today I’m going to help you with the why and also help you understand the basics of investing.
No need to thank me. Let’s get started.
Why You Need to Start Investing Now
Sit down and close your eyes. (Well okay, don’t close your eyes because you need to keep reading this.) Just sit down, dig deep within, and ask yourself how it feels right now being broke. It sucks right? Now imagine that feeling of being broke decades from now only without your health, without your youthful looks, without your family supporting you, and without your vibrant energy. That’s an even worse feeling, right?
The reason why you need to begin saving and investing right now is because you want to win at the long game. You want to make sure you don’t have to rely on a weakened social security program to care for you in your old age. The old saying is true: if you want to achieve what others don’t, you have to do what others won’t.
The Difference Between Saving and Investing
Saving money and investing money are related, but they operate a bit differently. Saving means taking money you already have and putting it somewhere safe so you don’t lose it. Investing means taking money you already have and putting it somewhere smart so that it grows into more money.
There are lots of places to save your money, and there are lots of places to invest your money. You can save money by stuffing it all under your mattress, placing your cash in an old coffee can, or depositing it into a bank account. And there are lots of places to invest your money. You can buy a used car, restore it, and then sell it to a car collector. Or you can buy an old house, fix it up, and then sale it to someone else for a higher price. You can even give your money to crazy Uncle Larry who promises to share his profits with you from his waterless car wash business.
The Experts Benefit from Your Confusion
Sometimes when we hear terms like portfolio diversification, mortgage-backed securities, and unregulated leveraged derivatives, we feel like just giving up. One year, we’re told that the best investments are in real estate, then the next year we’re told to invest in gold. We’re told it’s best to buy stocks when the economy is on an upswing, and then we’re told to buy stocks when the economy is spiraling downhill. All of it is so ridiculous that your crazy Uncle Larry’s scheme of getting rich from waterless car washes is starting to sound pretty good.
Business author John Naisbitt said it best: “We are drowning in information but starved for knowledge.” Investment brokers and financial planners are the ones who benefit from public confusion. People who position themselves as financial experts can then sell their financial expertise to the rest of us.
The Basics of Investing
The financial industry is filled with lots of specialized vocabulary and ideas. But I listed below the five absolute basics of investing you need to know. This will get you started, and then as you get more involved, you can learn about smaller details and more complicated financial ideas.
Stocks represent ownership of a company. A company’s stock is broken into tiny pieces called shares that are available for you to own. Many huge companies and corporations offer millions and millions of shares of their stock to the public. You become a stockholder if you buy any amount of shares—even one share. If a company is a publicly traded company, this means that the company offers shares of its stock to the public. Companies celebrate the day when they become publicly traded because when lots of people buy these shares, the company can use that money for their business needs. Each company’s stock has a stock price that indicates how much one share is worth. (For example, about fifteen years ago, my wife thought we should invest in Google but I thought the price was too high at $85 per share. At the time, we probably could’ve purchased ten shares for a total of $850. I checked Google’s stock price this morning. It was $793 per share. That $850 investment back then would be worth $7,930 today.)
Let’s suppose a business wants to raise money. It can offer shares for sale (stocks) in which people are partial owners of the company, and they win or lose whenever the company wins or loses. But the company has another option. It can offer bonds. A bond is a way for a company (or even the government) to raise money by actually borrowing it from people like you and me. The most common bonds are government bonds.
All bonds have three components: a dollar amount, an interest rate, and a length of time. So let’s say I invest in a $1,000 bond from my city at 5% interest over 30 years. What that means is that I just gave my city government $1,000 and they’ve agreed to pay me 5% of that amount (which is $50) each year for the next 30 years as a thank you for “loaning” the money. At the end of that 30 years, the city government gives me back my initial $1,000.
Interest rates can work for you or against you, depending on where you stand on the end of the deal. In the case of bonds, the interest rate is working for you because the government is basically paying YOU a fee for letting them hold your $1,000 for a few decades. The advantage of investing in a bond is that they are usually less risky than stocks because all the terms are (mostly) guaranteed. You agree to invest in a bond, and the bond issuer agrees to the terms. Everybody gets their money. The disadvantage of a bond is that there’s less potential for HUGE growth compared to company stock. Imagine if, years ago, I invested $1,000 in a bond, and another $1,000 in Google. The return on those investments would be really different. BUT REMEMBER: the reason why it feels like a risky gamble to purchase stocks is because it’s hard to figure out which company is going to be the next Google.
A mutual fund is interesting. Think of it like this. Instead of buying direct shares of a company’s stock, you put your money in a big pot with other investors, and then all that money is used to invest in a large group of companies. That’s a mutual fund. You can buy shares of mutual funds in much the same way you can buy shares of stock. A financial company manages the fund for you. There are thousands and thousands of mutual funds to choose from. If you love companies that are working to save the environment, you can invest in a “green energy” mutual fund made up of a group of these companies. You can invest in a technology mutual fund made up only of technology companies. There are mutual funds in all kinds of sectors including health, real estate, communications, and many others. You can even invest in a mutual fund made of other financial investment companies.
This is like the grocery store for stocks and bonds. (Actually it’s more like a flea market or swap meet instead of a grocery store because everybody’s yelling and screaming and negotiating). A stock exchange is simply the place where people buy and sell stocks and bonds. Most (but not all) countries have stock exchanges. For example, in the U.S., there are two major stock exchanges: the New York Stock Exchange (NYSE) and the NASDAQ.
You can’t just drive to northern California, go to Google headquarters, knock on the front door, and ask them to sell you a share of their company. (Trust me. I tried it. They said no.) That’s why you need a stock broker. A stock broker is the person (or firm) that handles the transaction between a buyer and seller (or between you and the company). All brokers take a fee. Full service brokers charge the highest fees because they do the most work for their investors. They don’t just handle transactions. They manage your whole portfolio, provide you with financial advice, and offer lots of research and information. In exchange for all this service, they can charge a yearly fee of about 1% of your total portfolio value. That’s really expensive. What most average traders like you and I will do is use a discount broker company (like E*Trade, for example). Instead of paying a yearly fee for a personal broker and all of his advice, discount broker companies charge a small fee (around $10) for each trade you make. That’s it. No personal advice, no custom research. Pay a fee, make a trade. Done and done. This is usually cool for most of us who don’t buy and sell stocks every day. These days, technology has simplified the whole process. I can go online to a discount broker, sign in to my account, pick a company, buy some shares, sign out, and then sit on my couch for 40 years and watch my money roll in.
You’re young and you’re going to make mistakes and that’s okay. Here are a few additional things to remember that might minimize those mistakes.
- Getting excited about one company is like getting excited about a single number on the roulette wheel at the casino. Spread your investment around. Diversification means maintaining a diverse array of investment vehicles including stocks, bonds, mutual funds. When you’re young, time is on your side, so you can afford to be risky (more stocks, fewer bonds). When you’re older, you have to be a little more conservative (more bonds, fewer stocks).
- Take advantage of your youth. The most valuable resource is time, and it’s especially true when it comes to investing. I’m currently 43-years-old. Let’s suppose I opened an account and threw in $1,000 to start with. Then I took $100 each month from my paycheck and deposited that into my account. Assuming a (pretty conservative) 8% annual rate of return, I would end up with $47,440 when I turned 60. Now let’s suppose you’re 24-years-old and you did the same thing by opening an account with $1000, followed by deposits of $100 each month. When you turn 60, you would end up with over a quarter million dollars ($258,452 to be exact).
These are the very basics of investing. There are smaller details you learn along the way, but the point is to begin with the basics and begin to get involved now.