What They Don’t Teach You in School About Money: Investing 101
Together with NDR, we’re creating a series of articles titled “What They Didn’t Teach You About Money in School”, in which we go over the most important money-related topics you’ll come across in your day-to-day life. Today, we’re kicking things off with our first topic: investing.
Investing is all about putting your money to work for you, with the goal of preserving your purchasing power and growing your wealth over time. (And a very powerful method in doing so!) Over the last 30 years, the average stock market return of the S&P 500 was about 10% annually. That means that for every 10 USD you invest at the start of the year, you could have gotten back around 11 USD at the end of the year. Our goal with this blog is that you have everything you know to potentially take a piece of the pie, too! Because we are here to empower you financially so you can live your best life.
First, we’ll list the reasons why you may want to consider investing, and why it may be better to start sooner than later. After that, we’ll explain a couple of fundamental concepts you should know before you buy your first stock or index fund. When you have a good grasp of these, we’ll give you some tips on how to buy your first stock or index fund. And to round things off, we’ll give you a few things to remember when you’re starting with investing. We hope that after reading this article you’re well on your way to your stronger financial future. Let’s make your money work for you!
There are many reasons one might want to invest. One important reason is that by investing, it’s possible to outpace inflation. Inflation erodes the purchasing power of your money over time–as prices increase, you can buy less and less with the same amount of money. By investing your money, your money may be able to grow faster than inflation, allowing you to maintain your purchasing power over time.
Another important reason you might want to invest is that by investing, you may potentially build a nest egg for a comfortable retirement. By investing in the stock market and letting the money do its work, you can accumulate wealth over time. And if you “set it and forget it”, you can give compound interest all the room it needs to do its job. The earlier you start, the more time compound interest has to work its magic! (We’ll dive deeper into compound interest below.) Next to building your retirement fund, investing may help you to come up with the funds for a down payment for a house or your children’s education, too.
While I don’t like the term “passive” income, (I mean, nothing worthwhile in life comes to you passively, right?), investing may help you create a stream of “passive” income. As some stocks pay out dividends to their shareholders (more on dividends below, too), owning a significant amount of shares may result in a nice dividend payout. Or, if you hold government bonds or another fixed-income investment, regular interest payments could be made to you. And you don’t have to work for those anymore after you’ve made the initial investment.
Next to all these financial reasons, knowing that your money is working hard for you could help alleviate some of the money-induced stress you might be experiencing. By investing, you’re doing everything in your power to work towards a comfortable future, while also trying to outpace inflation today. Hence, by investing, you’re taking matters into your own hands, which gives many investors around the world a sense of control, peace, and security.
Now that you know why you might want to invest, let’s move on to defining a few fundamental concepts of investing. Okay, to be totally honest here, maybe you’ve heard about them in school once or twice… If you’ve heard about them before, let’s use this as a refresher, as these are important concepts to understand if you want to start investing.
In the world of investing, risk and return are two of the most fundamental concepts that you should know. And they are intricately linked. “Risk” refers to the possibility of losing the money you have invested, as there is no investment that 100% guarantees you’ll make money. Sure, some investments are riskier than others, but no investment is completely without risk.
“Return”, on the other hand, refers to the profit you may expect to earn on your investment. Generally, risk and return are positively linked with each other. The higher the risk, the higher the potential return, and vice versa. For example, stocks are generally considered more risky than bonds (more on those later), but stocks also have the potential for higher returns.
When you’re going to invest, the key is to find the right balance between the two. You want your portfolio to reflect both your risk tolerance and financial goals, so your money can do its job without you being stressed out by the risk.
As we’ve said earlier, the average stock market return of the S&P 500 has been about 10% annually for the last 30 years. That means that for every 10 dollars you invest in the stock market, you may have gotten back 11 USD at the end of the year. Then, if you keep this 11 USD invested and your return is 10% again, you may get back 12.10 USD at the end of next year.
Going from 10 to 12.10 USD is an increase of 21% over the course of two years. This is more than 10% + 10% (the return on investment in years one and two), which means “compound interest” is doing its job: The interest is compounding over time. The longer you keep your money invested, the more your returns may snowball. Now that’s the magic of compound interest.
Here’s something fun: If you want to see compound interest in action, check out this investment calculator. The longer you keep your money in the market, the bigger the red part of the pie chart. Check it out for yourself!
If you’ve ever sought information about investing online, you’ve probably heard the terms ‘bull market’ and ‘bear market’. But what do they mean?
When we’re in a “bull market”, stock prices generally rise. Investors are bullish, which means they are optimistic, and companies are performing. When the stock market is in a bull market, the average American is trying to get in the market too. ‘Bull’ means up.
However, when we’re in a “bear market”, it’s exactly the other way around. Stock prices are generally declining and investors are bearish, which means they are not that optimistic about what’s going to happen in the market. People are selling their assets, and companies are not doing that great. “Bear” means down.
What’s important to remember is that both bull and bear markets are parts of the economic cycle. They can last for years, or even decades, but you can be sure that you’ll encounter both a bull and bear market in your investing journey. It’s important not to let the state of the market dictate your decisions—you are the boss of your portfolio.
Another key concept, and for many investors the most fun one, is the dividend. Why is it the most fun? Because a dividend payout essentially means that a company is sharing part of its profits with its shareholders. If a company is going to pay out dividends, they usually do this once per quarter or once every year. As companies may choose to reinvest their profits into the business too, it’s not a given that whenever a company is making a profit, you’ll get a share of this as a dividend payout, though.
Let’s move on to the three most common assets one can invest in; stocks, bonds, and index funds. Below, we’ll explain the main differences between the three.
If you buy a stock, you’re buying a piece of ownership in that company. A company may choose to sell a piece of ownership by offering stock in order for them to raise capital to fund the business. That means that if, for example, you have one share of Company ABC, you own a piece of this company that equals one share. Then, if ABC’s stock price rises, you may profit from this price appreciation if you sell the stock. But, being a shareholder can be risky, too. If ABC has a bad year and its shares are not in demand, its price may drop, which may decrease the value of your piece of ownership. The potential return on holding a single-company share can be big, but remember, this comes with a fair bit of risk too.
A bond is an IOU (I owe you) that could be issued by a company or a government, however, most bonds are being issued by the government. By buying a bond, you’re essentially lending the government money, on which you will receive a pre-defined interest payment. A government is generally seen as the least risky investment option, it probably won’t go bankrupt.
Index funds are generally considered to be the most convenient investment vehicle you can put your money into. By buying an index fund you’re investing in a professionally managed basket of stocks, which means your portfolio is well-diversified from the get-go. A well-diversified portfolio means you’ll overall bear less risk. Sure, the potential upside is often lower than with single-company stocks, but you may also have a smaller probability of losing your money.
An index fund is a 1-on-1 replication of a complete market index, like the S&P 500. There are other funds too, like Exchange-Traded Funds (ETFs) and mutual funds. These are made up of a more tailored set of stocks and bonds. However, all these funds are made up of a basket of different assets, and that’s the most important thing to remember for now.
By now, you probably know that investing may set you up for a more comfortable future, and you’d like to start. But where to begin? And what assets to buy?
First, you want to pick a strategy. If you’re new to investing and plan to invest for the long term, the way to go may be to invest in index funds. Index funds are generally relatively low risk because they are well-diversified by definition. They truly make investing easy—you can “set it and forget it.” Or, as I like to call it “index and chill.” If you’re willing to take a bigger risk with your money you can buy single stocks too, but just know that there’s generally more risk assocated with that.
Then, you need to pick a broker and open an account, an intermediary through which you’re going to buy your assets. Pick a party you’re comfortable with. Here’s a list of renowned brokers that may suit your needs.
After you picked your broker and opened your investing account, it’s time to start buying assets. If you’re going the index fund route and want to know what stocks make up the index fund you’re buying, you can check out the specifics of each index fund online, for example through this website.
And if you want to make it as easy as possible, you can do so by automating your investments. At whatever bank you have your checking account, you can schedule periodic transfers to your investing account. Then, if your broker supports it (and most renowned brokers do nowadays), you can schedule periodic purchases of different index funds and stocks. After you’ve set that all up, we play the waiting game. Your money is automatically being invested in index funds or stocks, and you can relax and enjoy your free time.
If, after reading this, you’re still not confident enough to start investing on your own, there are plenty of resources out there that can help you get started.
Now that you have an idea about how to start your investing journey, there are some important things for you to remember along the way. Keeping these things in mind can help you stay focused on your goals and stay true to the path you’ve set out for yourself.
If you’re making your investment plan and picking an amount to invest each month or each quarter, it’s important to make it feasible. You want to be able to sustain the periodic transfers to your investment account without having to go into debt or make the rest of your life miserable.
When it comes to investing, having long-term discipline is one of the most important traits you can have. If you’ve made your plan, you want to stick to the plan. This means making your periodic deposit, buying index funds or stocks, and letting the money do its work. You probably want to take full advantage of the wonder that’s compound interest, right? Then it’s important to leave your money alone after you’ve invested it.
This brings us to the last point: Try not to be discouraged when you find yourself in a bear market. Let me remind you: The average return on the stock market over the last 30 years has been around 10% annually. That includes the dot-com bubble of the late 90s, the 2008 subprime mortgage crisis, and the COVID-19 recession. Taking your money out by selling your assets could potentially cost you precious time, and in this time, compound interest cannot work its magic for you. It’s a cliché, but it’s true: Time in the market beats timing the market.
Well, that was kind of a long read, right? However complex, we hope that after reading this article you have an idea of what to do if you want to buy your first stock or index fund. I’ve written this article so you can take a piece of the pie and live your best life, too!
Why do you want to invest? Is it mainly to build a nest egg for when you retire in a few (or more than a few) years? Or do you dream of living off of the dividend payouts of your portfolio?
Whatever your reasons for starting your investing journey, we hope this article has empowered you to take matters into your own hands. Just remember to make it feasible for your income and lifestyle, don’t forget the importance of long-term discipline, and don’t be discouraged by the inevitable bear market you’ll find yourself in. Let’s put our money to work and live our best lives!
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