The learning curve of investing may seem overwhelming, but it doesn't have to be. Learn about the three things that can make you a more confident investor!
Investing. It can be an intimidating word if you aren't doing it. But, if you are, and if you understand your investment process, that intimidating feeling shifts to empowerment.
If you are currently intimidated, here are the three things you should know before you start investing.
1. Investing is not exclusive to the old or wealthy
A lot of people associate investing with older people, or people who have a lot of money. This is one of my biggest pet peeves, because investing is for everyone- regardless of your age and income. It is not a tool exclusively for wealth that's already there- it's a tool for building it.
It's true that there are some financial things you should check off before you invest all of your money, things like an established emergency fund, or having any high-interest debt paid off, but you also don't have to wait until you are in the perfect place financially before you start investing, because that time might never come.
When I first learned about IRA's, I told myself I would start investing in a Roth IRA in a few years, once my student loans were paid off... but I ended up opening and investing in my Roth just a few weeks after making that goal. Why? Because I played with enough financial calculators to see that even just waiting one year could have a huge impact on my balance 40 years from now, and waiting three years, which is when I planned to have my loans paid off, meant a potential difference of $243,000.
Almost a quarter of a million dollar difference. Granted, this is assuming a fixed, annual interest rate of 7%, so the end results will likely be different, but the takeaway is the same. The sooner you can put money away, and the longer you leave it invested, the better.
Here is what $500 invested monthly (which equals $6,000 annually, also the contribution limit for IRA’s as of 2019) looks like growing at 7% for 40 years.
Versus 37 years.
The difference in principle, or the amount you actually invested, is only $18,000 (three years of $6000) yet the difference in ending balance is close to $250k. This is why so many people harp on about compounding interest, because WOW.
Investing should be a long-term game, and the more time you have, the more your money can grow.
2. Consistency is crucial
When you have a long time-horizon for investing, i.e. if you are in your 20's and saving for retirement in your 60's, consistency is going to be your greatest superpower when it comes to building your account. And the good news is, it's not all that hard to be consistent with the help of automation. Figure out how much you can afford to put away each month, set up an automatic withdrawal from your bank account to your investment account, and then set up an automatic investment schedule for those funds a few days after.
Another part to being consistent is being in the right mindset with your money. Many people think of savings as an expense, money that is taken away from them that they can't spend on themselves. While I do think that that you should treat savings as a bill, it's important to see the bigger picture. $250 slipping out of your checking account each month? Ouch... But when that $250 is going to your future self, and growing at 7, 9 or 12%... Oh, hellooo! (Disclaimer, there are some months and years where it will be in the negative too, but on average and over a long period of time, 7-12% is reasonable).
When you're investing, you are experiencing volatility unlike in a savings account, and share prices are constantly fluctuating. But, another huge perk to being consistent is you get the benefit of dollar-cost-averaging, which helps reduce volatility.
Let’s say you are maxing out your IRA every year with $6000. If you invest the full $6000 all at once, you are buying at whatever the market price is for that day, which could be high, low, or somewhere in the middle. But if you invest $500 a month, you will still end up with $6000 total invested for the year, but instead of one large investment at one price, it will be 12 smaller investments, all at different prices. Spreading your investments out reduces the risk of buying when the market is high, and instead will give you a more even average.
3. Understanding what you're investing in will help you stick with a long-term strategy
This is probably the most confusing area, and that's because there is a lot of stuff out there that can go into investment allocations and portfolios. Let's start with the basics.
When you are invested, it means your money is not in your account sitting in cash. Instead, you are using the cash in your account to purchase equities (stocks, ETF's, mutual funds) or bonds (government bonds, treasury bonds, municipal bonds etc.)
Equities typically are higher risk, because in exchange for your cash, you are given shares in the company (if it’s a stock) or a share that represents a large pool of companies (ETF or mutual fund). When the company, or group of companies do well, their value will go up, therefore making the value of your shares go up, making the dollar amount in your investment account go up.
If the company or companies do bad, the share value will go down. When you buy equities, you become a shareholder of the company you invest in. In the event of bankruptcy or companies becoming obsolete, shareholders are quite low on the list for getting their money back, which is where risk comes into play. The benefit of diversification in a mutual fund or ETF is that you own shares of hundreds or even thousands of companies within one fund, so if one (or a few) companies go belly-up, you probably won’t even notice. But, because there is a higher level of risk, there is often a higher return to entice investors.
When you are invested in bonds, your money is at a much lower risk, because instead of giving your money to a company to use for operating capital, you are loaning your money for a fixed amount of time, at an established interest rate. When you are in bonds, you aren't going to see crazy, double-digit returns, and you aren't going to see those double-digit losses either.
How much of your portfolio should be in equities or bonds will depend on your tolerance for risk, and how long you have before you need to access the money in your investment account.
If you are investing for retirement that is decades away, you could be comfortable in a 100% equity allocation. As you get closer to retirement and needing to withdraw that money, you might consider moving some to bonds to reduce volatility, that way you don't risk selling equities at a loss if you need to take out money when the market is down.
If you are uncomfortable with risk, and seeing your account balance go down, then you might decide to have more in bonds. This means your account will not grow as fast as it would being in 100% equities, but it will also not go down as much during a recession.
Being aware of your comfort level and investing in companies or funds you support and understand will help shape your behavior as an investor.
Investing your money over a long period of time one of the best ways to grow wealth, and having a calm, consistent approach will help improve your experience.
If you have questions about opening an investment account, or investing in one you already have access to, get in touch! Opening accounts and establishing an investment strategy for new friends is a big reason why Friend of Finance exists!