Updated: Apr 13, 2019
Hello Money Talkers! The fifth step to financial freedom is investing. Investing comes in many forms. But in any form, investing seems like a foreign concept for most. A lot of people think they don’t have enough money or enough knowledge to even consider investing. All of these concerns are bullsh*t! ANYONE can invest. Some types of investing are more complex, but some are super easy. You can begin with any amount of money. But it is up to you to start! So let’s begin... at the beginning.
What is investing? Essentially, investing is about putting money towards something with the expectation of getting more money back in the future. The best way to Invest is to buy assets with the ability to generate profits and cash flow.
Why should you invest? You might be like the millions of Americans who are afraid of the stock market so they do not invest. One common mistake the scaredy pants make is that they put the majority of their money into checking and savings accounts. This is a MISTAKE! Banks do not like to give away their money, and that fact is clearly reflected in the interest rates they provide. I used to have my checking and savings account at the same local bank. The interest rate on my savings account was 0.010%, that translates to, basically nada. But here is the kicker, when you deposit your money in the bank, the bank invests your money at 7% a year or more. This means that they profit off your money an average of 7% annually and only give you back a measly 0.010%! As ridiculous as it sounds, it is probably happening to you right now… so why not just invest your money yourself?
If you are not already convinced as to why you should invest, let me introduce to you to the power of compounding. When your investment begins to earn money, and then those returns start to earn money, your investment can grow very quickly. For example, if you invest $1,000 and gain 10% interest per year, you’ll have $1,100 after one year. The investment earns $100 in interest over the one year period. The following year is even better because the interest is based on the $1,100 instead of the $1,000. So you earn the interest on your initial principle AND the $100 interest accrued so far, making your $1,100 earn $110. Every year you will earn more and more interest because your interest compounds. So the sooner you begin, the more interest you can accrue.
How much should you invest? There is really no right or wrong answer here. As long as you are investing something you are on the right track. The general recommendation by most financial planners is that you invest about 10% - 15% of your earnings. However, if that’s not feasible to you at the moment, then you can begin investing in the market with whatever dollar amount you can spare and then build your way up to 10% and then 15% of your earnings. The more you invest the quicker that money can grow. The sooner you begin investing the longer your money has to grow and accrue compound interest.
What should you invest in? There are many investment vehicles you can choose from. Below I have listed some of the most common. I will not say which ones will work best for you, that is up to you decide what is best for your personal situation. However, I will say that as long as you are investing something you are ahead of the curve.
Investing In Yourself: Before I dive straight into investing in the market, I want to talk briefly about investing in yourself. As we have previously discussed, investing is about putting money towards something with the expectation of getting more money back in the future. If you invest in your education now then you can increase your salary in the future. If you invest in your business now then you can increase your earnings in the future. If you put money into yourself in any way that will potentially increase your earning potential later on, then that is the investment you want to begin with, increasing YOUR worth.
Now that investing in yourself is covered, it is time to get to the meat and potatoes of this blog post, investing in the market.
Stocks: Corporations have stock to represent ownership interests in the business. So a stock is essentially a share of ownership in a company. Companies list shares of their stock on an exchange, often to raise money to grow their business, and investors purchase them. Investors then buy and sell these stocks among themselves, and the exchange tracks the supply and demand of each listed stock. The supply and demand of each stock cause them to gain value or lose value. Stock returns come from capital gains and dividends. A capital gain happens when you sell a stock at a higher price than the price you purchased it. A dividend is the share of profit that a company distributes to its shareholders. Over nearly the last century, the stock market’s average return is about 10% annually for long-term investors that buy and hold their investments over time. This type of investing is the riskiest because you can potentially lose money (god forbid). However, with great risk comes great reward. This type of investing is also the most rewarding because you can exponentially grow your initial investment as well. The key to investing in the stock market is diversification, which simply means do not put all your eggs in one basket. If you want to invest, do not put all of your money into Stock A, because it may do well, but it may also do poorly. If you put your money into Stock A, B, C, D, and E then even if one is doing poorly the others that are doing well will make up for it. Basically, diversification is basically a way to describe owning multiple types of investment assets to CYA (cover your a*s!) Additionally, do not just start buying random stocks because Fulano told you to. Do your research and see which stocks look the most promising.
Bonds: A bond is essentially a loan to a company or government entity, which agrees to pay you back in a certain number of years with interest. Bonds generally are less risky than stocks because you know exactly when you will be paid back and how much you will earn. Because they are safer the reward is a little less, the average bond return is between 5%-6%.
Mutual Funds: A mutual fund is a mix of investments managed by an individual company. When you invest, you don’t choose specific stocks, bonds, etc.; the mutual fund does it for you. The diversification of mutual funds makes them less risky than individual stocks or bonds. The average return on long term mutual funds is 4.67%
Index funds: This is a type of mutual fund that follows the performance of a particular stock market index. A stock market index is a measurement of a section of the stock market. Research has shown that index funds, which are “passively managed” funds, perform better than actively managed funds, which have a fund manager choosing specific stocks and bonds in an attempt to outperform the market. The average return on a long term index fund is about 7%.
Money Market Mutual Funds: This type of mutual fund invests in short-term debt securities. They are the safest of all mutual funds but have the lowest return at just 2%-3%.
ETF: An ETF (Exchange Traded Fund) is also a type of mutual fund. It is made up of a combination of securities, stocks, bonds, and commodities that you buy and sell through a broker. They combine the diversification benefits of mutual funds with the trading ease of stocks and are available at various risk levels.
How do you invest? Now that you know what investing is, why you should invest, how much you should invest, and what you want to invest in, how do you actually put your money into these investments? The answer is much more simple then it seems, all you need is a broker. A broker buys and sells goods or assets for others. You can either go through a face to face broker or an online broker. Simply pick the brokerage firm that’s best for you, such as Fidelity, E-Trade, Vanguard, Charles Schwab, etc. You can physically go to the brokerage firm and sign up and open an account, or you can do so through their website. Depending on your investment approach, is which broker you should use.
DIY Approach: If you want to be more hands-on with your investing and choose your investment vehicles yourself then you might want to choose a brokerage firm that reflects that. According to Nerdwallet, the three best online stock brokers for beginners are, Ally Invest (low cost), Merrill Edge (no account minimum) and E-Trade (great resources to educate yourself).
Hands-Off Approach: If you know that investing is something that you want to do, but you do not actually want to be the one handling it, then maybe a robo-advisor is a good option for you. Robo-advisors will build you a portfolio designed to achieve your investment goals and do all the leg work for you. Robo-advisors have significantly lower fees than human investment managers. NerdWallet’s top robo-advisor picks are Wealthfront, Betterment, and WealthSimple.
F*ck it, I’m Hiring Someone to do This For Me Approach: If all of this seems too complicated, you can always hire an investment manager to manage your investments for you. They will pretty much do what a robo-advisor would do for you. However, since they are human they will charge you more but they will explain things more as well so that you can get a better understanding of your investments.
Once you have chosen a broker and opened an account, the next step is to fund it. Begin putting in your 10% or 15% and continue to do so. It might even be easier if you automated your deposits to your brokerage account. Make sure that you continue to monitor it and adjust it as need be. If you become more comfortable with your investments and decide to try something a little riskier than that is great. If you feel like you are not as comfortable with the level of risk you initial put on, then adjust your investments to fit your new risk tolerance level. Either way is fine, as long as you consistently contribute.
Basically, it does not matter what you invest in, as long as you are investing. By investing you grow your money passively. You should aim to invest 10%-15% of your annual earnings. Know your risk tolerance. Pick the investment vehicle or vehicles that fit your situation best. Invest in what you believe in. Also, do your own research. Diversify your portfolio to protect your investments. Consistently contribute to your investments so that they may grow faster. And finally, once you have begun your investment journey watch your money grow!
CONGRATULATIONS, you are one step closer to financial freedom!