Here we are, the topic everyone wants to hear about, investing. This is probably the topic that sparks people’s curiosity the most, but also is the most challenging topic for us to get our heads around. This is due to plenty of good reasons. The stock market can be confusing. Hearing about The Fed, bonds, treasuries, interests rates and more, can all be very intimidating and scare people away from the desire to learn about investing. But here’s the great part, investing can be super easy and actually requires very little effort from you. All you have to do is get started and I will walk you through this part.
You may have heard of terms like 401k, 457b, Roth IRA, or 529 plans. These terms are thrown around liberally and many financial advisors will lead you to think that you need to hire them to manage these highly complicated funds. So let’s begin with my most basic warning: DO NOT HIRE A FINANCIAL PLANNER.
My reasoning is very simple. These planners often don’t have your best interest in mind and their number one goal will always be to earn commissions off of you. Using fancy financial terms, bloated diagrams, and confusing numbers, they will have you believing that they’ve put your hard earned cash into some amazing fund that will make dollar bills rain down on you. They’ll talk to you about how they’re going to be constantly moving your money around as if they have all the best-kept secrets of the stock market in their back pocket. This is just plain false. Financial planners don’t have the secret to beat the market and most of the time they are just putting your money into funds they gain the highest commissions off of.
So, let’s open your mind up to the basic frame work involved in beginning to invest your money. This is going to be covered in future articles as well, so today we will begin with the basics.
1. What is the stock market?
The stock market is an extremely large group of various companies that are all publicly traded. This means that anyone can buy a small piece of a company (stock) and now have an interest in that company. For example, Apple is a publicly traded company which currently has a share price of about $200. This means that as of today, for $200, you can own a small part of Apple. This price is not consistent and will constantly go up and down based on a ton of different factors, including the political climate, the economy, and Apple’s profits and losses. Now this is where the risk comes in. If you purchase a share of Apple your hope is that the price will go up. If Apple performs well, and lets’ say it goes up to $220 per share, you have now made a 10% profit. The flipside is if that share goes down in price then you lose money. Sounds a lot like gambling doesn’t it?
2. Why should I invest in the stock market if it’s so risky?
Although the stock market definitely has its risks, there are ways to mitigate your risk and earn money. Over the past one-hundred years, the stock market has seen many up’s and downs. The first things that comes to mind may be the great depression where the stock market crashed. Most recently, the hard hitting recession of 2008 is still fresh in many of our minds. Despite these recessions, the market has still averaged a growth of approximately 10% or 7% with inflation, which is a great return on your money. Outside of starting your own business or getting involved in things like real estate investing, it can be difficult to find ways to grow your money by 10%.
3. What can I do to protect my money and not just gamble it away.
The first thing we want to focus on is not turning investing into gambling. We won’t be picking individual stocks or companies that we think may do well in the future because, let’s face it, we literally have no clue. Now there are people who get insanely rich off of investing this way. They spend their lives trying to beat the market and picking certain stocks they believe will do well. While that’s all well and good for them, it is very risky and can cause you to lose a substantial amount of money. For example, when I was about 20 years old, I thought it would be fun to buy some individual stocks. A friend of mine told me that the Oilsand business in Canada was going to explode and that the U.S was going to build an oil pipeline to Canada which would ensure the Oil companies would make a ton of money. So I put $500 into a stock called Suncor which specialized in the oil sand industry. 7 years later the price of this stock is exactly the same as what I bought it for meaning I didn’t make any money off this investment. (Lesson learned)
4. What type of investments do I put my money into then?
Index funds! Index funds! Index funds!
Index funds are the best friend of those who want to become financially independent. What index funds do is they track a certain area of the market or investments. One of the most popular funds tracks what is called the S&P 500. The S&P 500 is a fund made up of the 500 largest companies in the United States. So this includes Apple, Google, Microsoft, GM, Ford and 496 others. These funds allow a much higher diversification than just simply picking one company, instead of 1 you get 500 of them. Now what I’m mainly invested in is even more diversified. It is known as a total stock market index fund which means instead of investing in the largest 500 companies it is invested in the largest 3,600 companies. This offers more diversification and a little less risk as you now can rely on over three thousand companies to do well and stay afloat compared to 500 or just 1.
Now we still have much more to talk about so please be patient with me. In the next few articles I would like to give you a blue print of the different types of investments that you can get invovled in and how they will benefit you. We will touch base next time on IRA’s that are Individual Retirement Accounts which include both traditional and Roth. Also we will cover some plans that you may get as a benefit at work such as a 401k or 457.
While all this can seem confusing I promise you that investing can be very simple. As I’ve mentioned before I have been able to reach a networth of over $200,000 by the age of 27 and I would not have been able to do this if I didn’t invest in simple index funds over the last few years. So please ask any questions you may have and stay tuned for the next article in the investment series.