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 1styear. 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.
* As originally posted on http://centsai.com/getting-started-investing-basics/
“For the average person trying to save for retirement, it doesn’t need to be this confusing.”
That comes straight from the mouth of John Oliver, who delivered his rant against the finance industry last month on Last Week Tonight with John Oliver. In this episode, he hilariously chronicles a story of hidden fees, retirement investing myths, and points out that not every financial advisor legally has to have your back. You can watch it here. It is well worth the 20 minutes. https://www.youtube.com/watch?v=gvZSpET11ZY
Some traditional advisors like to throw tons of information at you and create portfolios with so many moving parts that you immediately think, I can’t possibly figure all this out on my own… I need ‘professional’ help! Just think of it as job security -- theirs, not your own. After all, once you find out the dirty truth -- that investing really isn’t that hard or that complicated -- they’ll no longer be able to prey on your ignorance.
Most of these advisors work on a commission basis; they are salesmen. In addition to annual management fees, they are often paid commissions on products they sell to you.
However, the Department of Labor is forcing some change. Starting in 2017, financial advisors will have to work in a fiduciary capacity when managing retirement accounts- they will have to act in your best interest. You can read more here:
This is great for Divvy customers, though nothing has changed on our end. We are fiduciaries (registered investment advisor with the SEC), and we recommend low cost, passive models… and no, we don’t earn any commissions or kickbacks. The subscription fee is what we charge and that’s all. You can learn more by checking out our FAQ here.
John also offers 5 solid tips to investing, which we’ve summed up for you below:
Start Saving Now: Not tomorrow. Not next week. Even if it’s only $100/month, anything you save will begin earning interest. If you invest those savings, that’s even more compounded growth. It’s ok to start small, just start now. It adds up quickly.
Low-Cost Index Funds: Lower fees translate to more little green soldiers working for you. Are you saving for your retirement or your financial advisor’s?
Ask if your advisor is a fiduciary: Many financial advisors work on a commission basis, which is an extreme conflict of interest. They make their living by selling you stuff. Only a fiduciary will put your needs first.
Gradually switch stocks to bonds: In general, stocks are more volatile than bonds. As you progress toward retirement, your goals will likely change from growth to preservation.
Keep your fees like milk - under 1%: Fees can really add up, especially if they are 1% of your portfolio. That means the more your account grows, the more you are paying - for quite possibly the same service.
Investing doesn't have to be complicated. Keep it simple. Use proven long term strategies. Minimize fees. Remove emotion. Wise investing is all about asset allocation, picking a strategy and sticking to it throughout thick and thin. If anyone tells you they can beat the market, run.