You have heard it talked about in social circles, at work, and on the news. One way or another you are hearing about investing. If so many people are investing, it must be a good idea. So ask yourself, "Why is investing such a good idea, and what should I do about it?"
The simplest answer to why investing is such a good idea is because it is a way for you to create wealth. It is a process that is painless (no physical labor involved other than typing on your keyboard or dialing a phone number). Also, the rewards can be plentiful. By investing your money in the stock market you can end up with a lot more money for retirement. What?! Take money and buy stock and it will turn into more money? Not exactly. There is a lot to know about investing. This article will introduce you to what investing is all about and what you should know as you get into the game.
What Is Investing?
Investing is devoting your time, resources or effort to achieve a desired goal that you have planned for. Investing money is the same process, but with a focus only on growing that money. When you invest money, you are taking that money and putting it into some form of a "security" (a term used to identify anything that is secured by other assets) – such as stocks, bonds, mutual funds, certificates of deposit, etc.
Where to Start
Don't jump ahead and think we are ready to start investing just yet. There are a few things that you should know before to actually spend that first dollar. This first bit of information could help you understand how investing works and how it will benefit you.
To start with, you need to know your goals. Remember those goals you have to someday retire, have the house paid for, and be able to travel the world without financial worry? Okay, so maybe your goals are a little bit different, but we all have them, and they are all somehow influenced by our financial situation.
Also, you need to know that time is your ally when you are investing money. This doesn't mean you can take your time to invest. It means that you need to invest as soon as you can and let time go to work for you. With time, stock prices tend to go up (even when there may be a drop in the price, it will generally rebound and go up). Also, with time, you accrue interest which will continue to multiply.
That leads us to a term that you need to become familiar with: compounding. Compounding is what happens when you have a sum of money that sits and earns interest. For example, if you have $100 that earns 5% interest each year, at the end of the year you would have $105. If it continues to earn 5% interest, at the end of the fifth year you would have $128. Continuing on at 5% interest, at the end of 25 years you would have $339. And you aren't adding any money other than the original $100. The additional $239 is money that is earned over time because the interest is compounding. Want to know something really cool? If you can find an investment that give you a 20% return, at the end of the 25 years, your $100 will have grown to $9,540. Imagine if you could invest $10,000 at that rate.
The last thing we will mention here that you need to know and do prior to investing is in regards to your debts. It is okay to invest when you have certain debts but not with others. Why? Well, to answer that just look at two different types of debt. First we will look at a mortgage debt. If you have a mortgage that was secured at the time this article was written you would be paying approximately 6% in interest on that loan. You most likely won't pay off the loan in one payment (if you can, you are welcome to pay mine as well). It will get paid off over time. But the amount you owe won't go up, it will instead go down. What you get in return is a house that will be an asset you own when the mortgage is paid off. And if you are lucky, the value of that house will appreciate (grow) while you are living there and paying off the loan. A mortgage, auto, or student loan is a debt that is okay to have while investing.
Next we will look at a credit card debt. If you have a credit card in this day and age, you may have an interest rate as low as 9.9% but most cards are looking at interest rates around 18.9%. If you have $10,000 debt on that credit card and cannot pay it off, interest will accrue and be added to your balance. This will cause the balance to go up which means you will have more to pay off.
Now looking at these two debts, which would be better to have? Obviously the mortgage is a better debt to have. This is one that you can continue to work on while you are investing. The credit card on the other hand is charging you more interest than you are likely to make on your investments. The interest on the credit card is compounding just like your investment interest earned is compounding. But the interest rate on the credit card compounds at a higher and faster rate than your investment would. This is a debt that you want to get paid off before you invest money. In fact, this is a situation where you could say it is your best interest to invest your money in paying off the debt before you invest it in stocks and bonds. Get yourself free and clear of these kinds of debts before you invest. When you get that done, you are ready to make some money like a savvy investor.
How Do I Invest?
Before you have started physically investing your money in some sort of security, you can begin to be a successful investor just by making investing part of your daily life. Think of it this way, every decision that you make that involves money (or can at least have a monetary value placed on it) is an investment decision. Do you need to eat out every day for lunch or can you save some money by brown-bagging it? Would it be better to carpool or use public transportation rather than commuting 30 miles to work? When you look at your life and every decision you make to be either a help or a deterrent from gaining financial wealth, you will find yourself making different decisions so that you can save money for investing. This is good. Before long you will ask yourself why you didn't change that habit a long time ago.
Does this mean that you should go back to the wishing well and get every penny you tossed in? No, but it does mean that by making good decisions on financial matters you won't have to. Even if you don't have any kind of an investment account started, you can begin your investing by paying yourself. Take the money you want to invest and pay yourself this money by putting it in a savings account. Guess what? If you do this you are already investing. Savings accounts will pay interest earned on the balance. The savings account will recognize profits due to compounding.
When you are ready to invest in other securities, you will basically do the same thing. The difference is that you won't be putting it in your savings account. Instead, you will be purchasing stocks and bonds, or putting it in a different kind of savings account called IRAs and 401Ks. To help you decide what method of investing is best for you let's look at the different types of savings vehicles (we'll use the word "vehicle" because these accounts take you from one financial position to another like a car takes you from one place to another).
What Should I Invest In?
There are several categories of investment vehicles to look at. Within each category are thousands of choices. Since we want time to work for your investments, we won't take all of your time right now going over every choice you have. Instead you will learn some basics and make your move from there.
There are basically three types of Short-term Savings investment vehicles: savings accounts, money market funds, and certificates of deposit (CDs). These are great vehicles to use if you need to invest your money for a short time frame, such as three years or less. The returns will not be as good as with other investment vehicles but they are still better than the coffee can under your bed.
Long-term investing can actually come in different forms which will be termed in this article as "fun money" and "retirement money". Let's look at options that fall under the classification of "fun money".
There are three basic vehicles you can use for long-term investing of your fun money. They are Bonds, Stocks, and Mutual Funds. Bonds are safer than stocks but also have smaller returns. They are issued by the government rather than banks and operate in much the same way as a CD that you get open at a bank.
Stocks give you ownership in a company which means they are only as good as the company. If the company is losing business or not making enough profit, your return on the stock will go down. If you aren't careful with these, you could actually lose money. However, if you happen to invest in the next Berkshire Hathaway (the company owned by Warren Buffet), you are likely to see a tremendous return on your stocks. (On a side note, one share of stock in Berkshire Hathaway was trading on Oct. 3, 2008, for as high as $140,900. In 1965 that same share of stock would have sold for $19. See what the potentials are for your investments?)
Mutual funds are a way for you to invest in both stocks and bonds. These are controlled by a fund manager instead of you. If there is something that the fund manager wants to invest in beside stocks and bonds, say for instance real estate, he has the power to do that. While this is sometimes thought of as the easier way to invest long term, you are also relying on someone that may not have your best interest in mind. Many kinds of mutual funds exist…you need to make sure you analyze your options before you choose so that you are getting what is best for your goals.
"Retirement money" may be invested through stocks and bonds just as you would invest your "fun money", but you may want to look at more traditional ways. It is likely that you have received some information from your employer about something called a 401K. This is just one type of retirement plan that exists. How it works (when you do it through your employer) is that you will contribute a percentage of your salary to the account. Your employer will likely match your donation up to 5% of your salary. That means if you sign up for a 401K through your employer and contribute $100 each month, your employer will also donate $100 each month to your account. Two for the price of one sounds pretty good. You might take a retail shoe salesman up on this offer so why not your employer?
Money contributed to a 401K account is withdrawn from your paycheck before taxes are calculated and withdrawn. There are other retirement plans that you should look at as well to determine what works best for you. Most commonly used along with 401K are Individual Retirement Accounts (IRAs), Roth IRAs, and 403Bs (which you get if you work for a non-profit organization). If you work for the government you get a 457 plan.
You may have also heard of Keogh accounts and Simplified Employee Pension (SEP) plans. These apply to self-employed people and small business companied. They are similar to IRAs in the way they are governed for contributing and withdrawing.
Retirement plans are governed differently from stocks and bond. With stocks you can sell shares and get a paycheck without any problems. With IRAs and 401Ks you have rules that limit when and for what reasons you can withdraw money. You may even have to pay back what you withdraw (with interest). The reason for the rules is to help keep plan management costs down. They also help deter you from withdrawing money for frivolous reasons.
As you can see, it is well worth your time and effort to research all of your options. If you get into the investment game with some of these plans without knowing just what you are doing, you could get yourself into a world of problems that won't help you achieve your financial goals. There are many websites that offer information to help educate you on what your options are. A great place to start is on the Motley Fool website (www.fool.com).
When Is The Best Time To Invest?
Since time is an ally when it comes to investing your money, the sooner you can do it the better. The longer you debate what to invest in, when to invest, and how much to invest, the longer it will take you to amass the fortunes that await you. This doesn't mean that you don't just jump in to the deep end and get in over your head. You should start out with what feels comfortable to you, unless you are a risk-taker. If you like the risk, good luck and make sure to wear a life jacket.
Educating yourself on investment opportunities will be one of the best time investments that you can make. Working with a broker or account manager will be valuable as well. You will be able to learn the ins and outs of trading in the stock market, moving mutual funds, redistributing retirement money, and other ways that you can be successful with investing. When you encounter a time of economic downturn, they can advise you on what you what you should do. But you shouldn't rely on them alone.
When you hear rumblings happening with Wall Street, it may be tempting to get out of your stock investments. However, be careful to fall into the flow of gloom and doom that the media portrays. Monitor the market on your own and with the account manager you work with. Also, review your investments. If you invest in stocks you need to review them regularly to see if they are beating the market. If you have invested in bonds you don't have to worry because those have a guaranteed rate of return. Set aside time to review your portfolio. If you can do it weekly, that is great. At minimum you should do it every three months.
Following the advice and using the information given in the article is just the beginning. Look at what you want to accomplish, research what will get you there, and get working on it. Now is the time, and time is on your side.