The Super-Easy Guide to Investing For People Who Know Nothing About It
Investing sounds scary. It sounds like it should be done by a rich guy in a suit on Wall Street. It sounds like you need to know a lot of complicated things, have a lot of money, and take a lot of risks to be an investor.
The awesome news is that is actually not true at all. Investing is super easy, anyone can do it, and it’s one of the wisest things you can do. I really mean it. Investing is easy!
What is investing?
If you invest in the stock market, you are buying a small part of a company or companies, and you are hoping that those companies will later become more valuable than when you bought them. And when that happens, you make a profit! If they become less valuable in the future, though, you lose money. So you could invest $100 and that could become $110 the next year, or it could become $90.
That sounds risky. Why should you invest instead of just holding onto your money?
Because you need to invest. The value of money goes down every year due to inflation. The reasons for that are kind of complex, but all you need to know if that you have $100 one year, it can only buy you $98 worth of stuff the next year. And that keeps happening every year. So over the years, you lose a lot of money just by holding onto it and not investing it.
Okay, so you need to invest. How are you supposed to invest without it being complicated and risky?
That’s the beauty of successful investing in today’s world. It’s so easy.
There’s are many different ways to invest, and I won’t go into all of them. You may have heard of CDs, stocks, mutual funds, options, futures, blah blah blah.
Don’t worry about all those different things. You can be a successful investor without knowing about nearly all of them. Let’s keep it easy. Let’s just stick with mutual funds.
Why? Because we want to make investing easy, low-risk, and with a high chance of success. Mutual funds are great because they are a package deal — instead of investing in one company, like you would if you bought one stock, by buying a mutual fund you are buying a package of little bits of many companies’ stocks. Instead of owning one big piece of one company, you own a bunch of tiny pieces of a lot of companies.
That’s great, because the key to low-risk investing is diversity. You want to own a lot of different companies’ stocks in order to keep your risk down, because that way if one of them does terribly, you may barely notice it.
Not only is diverse investing safer for you, it’s actually smarter. That’s because in the long run, no one person or group of people have consistently been able to predict which companies will become more or less valuable. Wall Street is basically Las Vegas — taking big risks and hoping for the best. You can make a lot of money quickly that way, but you can also lose it all in a flash.
We want to avoid that craziness, and instead be confident that we are making a lot of money over a long period of time. We can’t predict which companies will do well, but we do know that over time, the stock market — by which I mean, the entirety of all the companies of the stock market — does do well. The stock market, in the long term, always goes up.
Stock market growth
Here are the combined values of the largest 500 companies in the US across nearly the entire past century:
You’ll notice there are periods of growth (the rises) and decline (the drops). Don’t be worried about the drops. Over time, the total stock market’s value goes up — by a lot. And in the long run, a diverse investment portfolio always goes up, too.
If you invested just $100 in a diverse mutual fund in 1980 and did nothing else, it would now be worth $7,165. Incredible — that’s a huge gain and you didn’t have to do anything but make one small investment!
Now, let’s say that instead of just investing $100 once in 1980 and being done with it, you choose to invest $100 starting in 1980 and keep doing that once a month until when I’m writing this now, in December 2018. Guess how much you’d have?
You’d have $619,000, even though you only invested $46,500 of your own money!
What this means is that you don’t need to save a huge amount of cash in order to make a lot of money. That’s because through investing, your money will work for you.
When the value of the companies you invested in goes up (as it did in these examples, from 1980 to today), that means you make a profit over what you had invested. That by itself is great!
But the profit you made from the increase in stock price wasn’t the only thing that earned you money in these examples. Let’s learn a little more.
Compounding and dividends
There’s a neat thing called compounding. Not only are your investments usually worth more over time (as shown by the graph above), you can automatically reinvest those profits you earned to buy even more stock, which then produces its own profits, and so on — and that process is called compounding. So if you invest $100 and make a 10% profit, or $10, at the end of the year, you now have $110 invested. The second year, if you make a 10 percent profit again, that $110 will now be worth $121. And the third year, $133.10, and the fourth year, $146.41, and the fifth year, $161.05. Over a long period of time, compounding makes you a lot of money.
And it gets even better. Not only can you automatically reinvest the money and make more money that way, companies pay you dividends. Dividends are awesome — they are money, often amounting to about 2% of the value of what you have invested (though the percentage varies from company to company), which the companies pay you every year just for being their stock owner. Those dividends can get automatically reinvested as well. And over time, that makes you a ton of money, too!
Summing it up
So we can see, all things considered, that the amount you can make in profit is massive over time, with a relatively small investment of your own.
All you need to do is invest a small amount over a long period of time in a diverse fund, or a few diverse funds.
So, it’s true: Investing can be easy, doesn’t require much money or knowledge, and is relatively low-risk. Neat!
How to Invest
You’ve learned about how investing works; congrats! The next step is learning how to actually go about investing your money. I’ll talk about how to do that in a Part 2 to be posted soon — when I have the link I’ll update it here. Stay tuned!