We all know we should invest, but a lot of people don’t know where to begin. The financial services industry has done a great job confusing everyone, but investing doesn’t need to be complicated.
A good place to begin is to note that investing isn’t a get-rich-quick scheme. Taking control of your personal finances will take work, but it will be worth it.
What is investing?
Investing is transitioning from a tool to help you retire to a necessity to be able to retire. You can only work so many hours in a day. Investing is a way to give your money a job and have it go to work for you to earn more money over the long term (ultimately while you sleep). Think of it as a way to have a bunch of little green soldiers working on your behalf.
What investing is NOT?
It is NOT Gambling. It is NOT day trading. It is NOT trying to find the next hot or sexy stock that will double in the next month. It takes thorough analysis and planning with the expectation that over the long term it will help you reach your goals. It is a long term strategy or plan used to help you achieve your goals.
Let’s face it, the days of pensions and gold watches are long gone. Even the military is talking about transitioning away from pensions. Social security may or may not be here in 20 or 30 years. We constantly see stats in the news about how few people are saving enough to retire. Not saving enough plus poor decisions with investments makes for bad math. For most of us, our ability to save and plan for retirement falls on our own shoulders. If you want to be able to retire, you need to save, invest, and be able to make good decisions along the way. It makes sense to have a general understanding of what you’re doing.
How does investing work?
Great question. Thanks for asking! The simple answer is compound interest. Exsqueezeme??? Stay with me for a moment…
Albert Einstein referred to compound interest as “The most powerful force in the universe. He who understands it, earns it. He who does not, pays it.”
Compound interest is a math concept that you can actually use daily, without trying to solve for the square root of x or using a protractor. Compound interest like your money’s powerful army (or Marines…Ooh Rah!). To feed it, you need time and reinvestment of earnings. The more time you give it, the more potential money you’ll be able to make from your original investment.
Let’s walk through a hypothetical example to illustrate the concept.
Pretend you invested $10,000 and were able to get 5% return. After 1 year, you’d have $10,500. Now if you reinvested the $500 you made into the original $10,000 at the same 5% return, after the 2nd year you’d have $11,025. The 2nd year you actually made $525 instead of $500. This is possible because you were able to get 5% on a larger number when you reinvested the earnings. It is only $25 more, but you didn’t have to work any more hours for the $25. If you reinvest the earnings again at the same 5% return, after the 3rd year you’d have $11,576.25. You would have made $551.25 that year, which is over $50 more than the 1st year. This trend will continue as long as you keep reinvesting and earning interest. Imagine the impact this could have over 20-30 years!
* Hypothetical example used to illustrate concept of compound interest.
Compound interest is a powerful tool. The earlier you start investing (even if it is a small amount), the more time you give your investments to work for you. By reinvesting the earnings you’re able to boost the growth of your original investment and maximize the earnings potential.
There are many different investments out there with varying degrees of risk/reward. We will get into that in future posts. It is important to have a solid foundation before getting into that. Hopefully you now have a better understanding of what investing is and the power it yields. Remember, Spiderman once said, “With great power comes great responsibility.” It is on you to take an active role in your finances.
If you’ve got an emergency fund in place, and you’ve paid off your high interest debt, you’re financially ready to start investing. Discipline investing takes a little education and a lot of self control. If you feel overwhelmed with the options available to you, consider investing with Wealthfront a robo-advisor that will not charge any management fees for the first $10K you invest and has just a $500 investment minimum.
If you want to invest outside of the stock market consider passive real estate investing through Fundrise (just a $1000 minimum).
Want free tools to help you learn more? Consider DIY.Fund.