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You’ve probably heard a lot about investing. You might be scared of it. You might not know what it means. Well, here we are to sort all that out.
Put simply, investing is putting money away into a ‘platform’ in the hopes to receive more in the future. You can put the money away and forget about it, or you can get involved day to day.
Investing is the basis of making your money work for you, instead of working for your money (thanks Kiyosaki). Say you put away $50 into one of these platforms with a 7% interest rate. That means that next year you will have $53.5 (7% of 50 plus 50), with no effort. Not much? Agreed. But if you put $120,000 with a 7% interest rate, next year you will have $128,400. And that’s 8,400 of free money (crowd goes wild).
‘But I don’t have 120,000 to invest!’ you say. Don’t worry, neither do I. As college students, we are notorious for being broke (*cough cough wrecked education system). However if start with an initial investment of $100 and every month you put away $100 for 20 years at a 7% interest rate, instead of having $24,100, you’ll have $51,428!!!!! That’s $27,328 of free money!! (sirens in the distance). This, is called compound interest. If you want to play around a bit more and see how much you could earn and with what potential returns check out the BankRate Calculator.
So if you’re an ambitious college student who wouldn’t mind some free money now and then, investing is for you. It doesn’t matter if you can’t do $100 every month, start small.
There are 4 main investment vehicles you can use to put your money in. Each has advantages and disadvantages depending on your personal situation.
This is probably the one you’ve most likely heard of. Stocks or shares are basically a tiny percentage of a company. When you buy a stock, you are effectively buying for example 0.007 of the company. It’s a way to be a bit of a company owner (cool right?). Even cooler if the company pays out dividends to its customers. Dividends are basically like a small monthly or annual salary as a return on your investment.
Say you buy 5 shares of the company Movicol (random box on my table) at $20 a share (that’s $100). That company might include in its policy to pay its investors $0.3 per share every quarter (that’s $1.2 a year). For 5 shares $0.3 isn’t much, but if you have 500,000 shares, that’s $150,000 of free money each year. Did I say investing was cool?
Of course, not all companies pay dividends, but if you’re putting in the big money it’s worth to take a look at the ones that do (most often it also means they’re doing pretty well).
You buy the stock online through a broker, and then you make a profit by either receiving dividends or selling the stock at a higher price (the whole buy low sell high thing). This is why you want to invest in a company you believe will do well and not go bankrupt in a few years (selling at a lower price = big losses).
Bonds are basically a loan vehicle, where you effectively loan out money to a company in exchange of monthly/quarterly interest payments and the full repay in the future.
Say you loan $50 to company Movicol with a 3% yearly interest rate. Movicol might agree to pay you the $1.5 of interest every year until they decide to pay you back the full $50. That’s another $1.5 of free money (yay). But it’s not much.
Bonds have a really low interest rate and if you combine it with inflation, your profit is very low. People really only invest in bonds if they’re extremely scared of risk or if they’re nearing retirement and would rather not lose all their money in the stock market.
Imagine mutual funds as basket holding a combination of stocks, bonds and any other investment vehicles. You put your money into this basket and it’s then either managed by an investment manager (a living, breathing human) or an index/robo. The investment manager is supposedly an expert and decides how much of your money should go into stocks, bonds, etc. He/She will also determine from which companies to buy stock from and when to buy/sell. They have high management fees and can often get it wrong (humans, remember).
Exchange-Traded Funds (ETFs)
This index is really like a mutual fund basket but instead follows the market. This means that you choose the percentage of stocks and bonds in your basket of a specific market (the S&P 500 or the FTSE 100, for example). By buying ETFs you are effectively buying the entire market at extremely small percentages. You will hold stocks and bonds of all the companies in that market, which means that whatever the overall market return is, that is what you’ll get (on average, it’s at 7%) For more info check my article on WTF are index funds.
There are other investments such as real estate, private equity, hedge funds, and a few others which are for the more advanced because of the higher level of expertise and of money needed. But if you’re intrigued, here is more info.
What it takes to be successful
Stocks: Being successful with stock investing means investing in a specific company that you believe will be successful. This means a lot of research. A LOT. You want to be 100% sure that that company will succeed. And that takes time, effort and financial knowledge (raise your hand if you can read a balance sheet) (if you did, congrats to you). Stocks are risky, because not only can the business you’re investing in go caput, but outside influences could convince you to sell at a BAD time.
Bonds: You can’t get successful with bonds. They are simply a low return low risk investment vehicle that won’t give you much free money. But as I said before, they’re great if you want to diversify your portfolio a bit more or if you’re reaching retirement and want to be a bit more secure.
Mutual Funds: Success with mutual funds happens when you have a LOT of money to invest. Mutual funds have high fees and you need to be able to afford them in order to see some kind of return. You also have to trust the person managing your company, will they be able to beat the market (so have a higher return than 7%) for the next 10 years? (unlikely).
ETFs: To get successful with ETFs you need to be willing to do research on which index to buy (low management fees, diversification, etc). You also can’t let emotions get the best of you. If the market starts crashing tomorrow and you decide to withdraw all your money, you’ll effectively have made a loss. Remember that the market corrects itself, and that if you wait long enough you’ll get back your returns (that’s why I said the market returns on average a 7%). For more info check out WTF are Index Funds?
So now you know the three main types of investment vehicles and how each one works. Which one do you invest in?
Stocks are high risk because they are traded daily and keep fluctuating with value, but they also can have high returns. Bonds are low risk because you are loaning money with an agreement to be paid back, but they also have low returns. Mutual funds are a mix of the two or more, but they can have huge management fees and you need a big sum of money to get started. ETFs track the index which means a steady return every year and has lower fees, but the dividends will be much lower and you can’t let the news get to you.
Well, it really depends on your situation (it’s always the same answer I know).
But! If we take the situation of a typical student: broke, not an expert in finance and with little energy to spend hours researching, my and many people’s recommendation is ETFs (however remember I am no expert and cannot be held responsible for any decisions you take). With ETFs you don’t need a lot of money to get started, you won’t have to deal with high management fees and you’ll benefit from a steady interest rate of 7% each year instead of the useless 2% from a Savings account.
And if you feel intrigued and want to learn more, I’ve created a little index at the end to help you do some research:
From Millennial to Millionaire by Matthew Miller
The Little Book of Common Sense Investing by John Bogle
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