The Beginner’s Guide to Investing
What is Investing?
"What IS investing? What does it mean?"
I have heard this from almost all of my clients. Or at least, the ones who are brave enough to ask. If you don't understand what investing is, you are not alone.
Investing is putting your money somewhere with the expectation that it grows. Simple! Investing is not just the "stock market" either. There are other types of investment vehicles where you can put your money and expect to receive more money in return. Curious what different kinds of investments you could have? Here are a few:
Real Estate (flipping, buy & hold, rental)
Precious objects (art, precious metals)
Business (your own!, stock ownership, corporate debt)
Venture Capital (high risk, high reward)
Investing also applies to concepts other than money. You put forth the effort, time, and energy in the hopes that there is a reward at the end like working out or honing a skill. The reason you may equate investing to the stock market is that there is a whole network of people that surround it whose main job is to get you to invest such as advisors, companies, brokers, and traders. The other types of investments don’t have such a robust network dedicated to reaching you. However, that doesn’t mean they are not good investment opportunities!
There are so many ways to make money. The average millionaire in America has seven different income streams. These come from one or more of the investment list above. If you are a little iffy about investing in the stock market, try out another investment opportunity you are more comfortable with.
To reach financial freedom, you need your money to grow. Having some investment, regardless of what it is, is necessary to achieve financial independence. Next, we will discuss how your money grows in the next installment of our investment series with compounding.
How does investing work?
Now that we know what investing is, we need to address how investing works. Investing works because of compounding. Compounding is an asset's ability to generate earnings (capital gains and interest) that are reinvested to make more profits. Confused? Let's try an example:
If you have a $10,000 investment that generates 10% at the end of the year, you now have $11,000. If you kept the $1,000 in the investment account, instead of taking it out, that means you reinvested your earnings. If the next year your investment account also generates 10% you will have $12,100 because you started the year off with $11,000 invested instead of the $10,000 baseline. Compounding allows your investments to grow at a more significant pace!
Year 1: $1,000 return
Year 2: $1,100 return
That seems like a small increase of $100 now but the longer that you leave your money invested, the higher the compounding, and the more significant the amount of money you will have. Your money can grow at an exponential rate because your cash is leveraged so that your principal (the original amount of money you invested) AND its earnings continuously grow day-in and day-out.
Compounding is where the real magic of investing happens because money can grow on itself. The earnings you make from principal investments immediately gets put to work for you.
Fun Fact: Debt works in the same way! Have you ever noticed that you can't seem to get out of debt and that the money you owe has snowballed into something far more significant than what you originally purchased? That's because debt also compounds, but in the opposite direction. So, if you have a high-interest rate on a credit card and you keep putting off paying off the balance of your credit card, the debt soon can become unmanageable.
This phenomenon is why the poor get poorer, and the rich get richer. It's math!
Why is time critical in investing?
The final part of our beginner investor series! We have gone over what investing is, how compounding makes it work, and lastly, we need to discuss why time matters. Time is an essential part of investing. Why? Time allows your money to grow! The process of compounding allows your earnings to build on itself; however, it needs time to do that.
When your money is reinvested, it is usually due to an increase in the company's underlying earnings or a dividend. Dividends are usually given on a quarterly or semi-annual basis. Due to this alone, for your earnings to grow, it will take years to see a substantial return that will allow you the money for retirement.
There is also a concept known as the time value of money. The idea is that money available now is worth more than the same amount in the future due to its potential earning capacity. Meaning that if you're doing this investing thing correctly, money in the future should be worth more than it is today.
Time is one of the essential factors in investing, and one of the myths of money is that you can figure out this investing thing later. It is BETTER for you to invest a minimal amount of money now than for you to put away a massive chunk of money in the future. Starting with even $50 a month can change your entire financial trajectory. It doesn't take a lot of money, but it does take a lot of time. If you are young and you have the time to start investing I urge you to do so. Your financial life could depend on it.