Make Your Money Make Money
The practice of using money to make more money is known as investing. Many people picture investing as a scary black box meant only for Wall Street traders in suits to operate, but that’s just not true. Investing can actually be quite simple.
First let’s go over some basics, starting with general market trends. The market naturally goes through what’s called Bear and Bull cycles. During Bear cycles, the market goes into hibernation, economic growth is slow and stock prices tend to go down. Then it switches into a Bull cycle, where the market charges ahead, stock prices skyrocket and economic growth explodes.
Above is the DOW Jones average market index over the past 100 years. Just by looking at how the market value changes over time, it’s clear that it goes up and down in cycles. However, there’s an important distinction to make between Bear and Bull markets. Bear is rarely as negative as the Bull is positive, meaning that over long timeframes the general trend of the market is up. This means that money left in the market will end up growing in the long run.
So how does one invest without being a high power trader with an in-depth knowledge of stocks to buy? There’s two approaches to this. The first is to just get someone else to manage the money for you. This can be through a Mutual Fund, a type of investment which pools your money with other investors. Mutual funds can be managed by a professional or by a robo-advisor, like Wealthfront and Betterment. Robo-advisors are a new crop of investing companies that prefer algorithm driven investment strategies without much human involvement, which keeps fees low and decisions emotion-free. (Mutual Funds, Wealthfront, Betterment .
Another approach is to invest in pre-diversified funds like an index fund or an Exchange Traded Fund (ETF). When you invest in an index fund, that money is split around many stocks so it follows overall trends in the market instead of changes in individual stocks. An ETF is similar, but can be based on any bundle of stocks, for example an index fund might represent the DOW Jones, but an ETF can represent something like the tech industry.
That’s all well and good, but what if you invest right before a market crash? I asked myself this same question, and found this article by CNBC. It describes the story of Bob, the imaginary unluckiest investor ever.
Bob only invested money right before market crashes. This means that he bought stocks at their highest price just to watch them tank the next day. Unlike other investors however, he stayed in the market through thick and thin, simply leaving his money. Despite the crashes, Bob STILL came out ahead, with an annual return of 9%.
9% sounds good, but how much actual money does this amount to? Let’s get an example situation where you start investing now and pitch in $2,000 every year (That’s 5% of a $40,000 income). What happens if you start at age 30 and retire at 65, that’s 35 years of investing. You would actually finish with a hefty sum of around $496,000. That final sum is $70,000 in money you invested and $426,000 interest. Not bad.
30 seems a little late to start investing, let’s just change that by a measly 5 years, can’t make that much of a difference? With those 5 extra years your total sum goes from $496,000 to $791,000. That’s a huge increase!
So how do you get started as an investor? There’s a couple easy ways. You could open a Vanguard, Blackrock, or Fidelity account and invest in one of their total market indices, which automatically diversify your money over many stocks, so the value of the index follows the value of the market (Vanguard , Fidelity , Blackrock).
That’s really all there is to it, becoming an investor takes less than 15 minutes and has enormous effects on your personal finance and the most difficult part is setting up the account!
Quick recap: Market cycles through Bear and Bull, but on average it increases over time. Investing doesn’t need to take constant monitoring and research. Investing in an index fund, ETF, or mutual fund can be simple and effective.
Got any questions? Have ideas for new topics? Please email me at cedrib@umich.edu and join us next time where I talk about the biggest mistake in investing! Subscribe for more cool articles!
