A Beginner’s Guide to Smart Investing
There are many headlines telling you to start investing, buy gold, save 15% of your salary for retirement, but also avoid tech stocks because an AI bubble is about to burst. Which of these headlines are right? And what should you actually do? I’ve spent almost a decade in banking and I’m going to cut through the jargon to give you a tried and tested strategy that works. I’ll tell you exactly what you need to be doing not only to protect your finances but also to make sure you come out ahead in the long run.
Understanding Inflation and Building Wealth
At its core, investing is just using your money to make more money. The first reason you need it is inflation, which makes your cash lose value over time. Prices rise, but the money sitting in your account doesn’t. So, if you’ve got 1,000 sitting in your account, in a few years time, it might only buy you 800 worth of stuff. Doing nothing feels safe, but it’s actually a slow way to lose your money. The second reason you want to invest is because it is the easiest way to get rich and build wealth because we are living in an economy where owning assets like property, stocks, and businesses is rewarded far more than simply earning a salary. Someone who bought a house over 20 years ago has probably seen its value more than double. Someone who invested in the stock market has seen their money grow around 8 to 10% a year on average if they did it correctly.
Escaping the Earning and Spending Cycle
But salaries have barely kept up with inflation. And so if you want to stop feeling like you’re constantly falling behind and in this cycle of just earning, spending, earning, spending, you need to understand and start using this to your advantage. You need to be investing.
How the Stock Market Works
Now we’ve covered why investing matters. Let’s talk about how the stock market actually works. Because it’s one of those things everyone’s heard of, but very few people really understand. When you buy a share, you’re literally buying a small piece of a company. So if you buy one share of Netflix, you now own a tiny fraction of Netflix. So, you’re basically saying, I believe this company will keep making great products and keep becoming more valuable over time, and I want to make money from that growth. Once the company has decided to offer shares to the public, you can buy those shares on the stock market, which is basically just a marketplace where people trade tiny pieces of thousands of different companies, and those prices go up and down all day based on what people think that those companies are worth.
Ways to Make Money and the Risk of Individual Stocks
Now, there are two main ways you can make money from this. The first is when you buy a stock and the price of that stock rises. So if you buy a share in Netflix for 100 and then a few years later it’s worth 150, you can sell it and make a profit. It’s that simple. The capital gain is your profit. The second way is through dividends. Some companies share their profits with investors by paying them dividends on a regular basis. Some companies pay dividends every 3 months, but others are also annually. It’s basically the company’s way of saying thank you for being a shareholder and to encourage people to keep investing in there. Now, you’re probably thinking, okay, well, that’s all well and good, but what actually do I invest in? Do I invest in Netflix? And you could do, but it’s a bit risky.
Lessons from Past Market Leaders
Even though Netflix is one of the biggest companies in the world, it’s risky because even the biggest companies can go out of flavor or struggle for years at a time. For example, remember when we all had a Blackberry? If you bought one BlackBerry stock for $144 back in June 2008, it would be worth $4.52 today. Back then, we all thought that it was going to be the next big thing. Very few could have predicted that within a few short years we would ditch BBM for iMessage or WhatsApp. Even if you spend your evenings reading company reports and analyzing balance sheets, which realistically not many of us want to do, it’s incredibly hard to know which companies will do well in the long run. That’s why most successful investors don’t bother trying to analyze and guess the winners. Instead, they just buy all of these big companies at once through something called an index fund.
Investing in the S&P 500
An index fund is basically a big basket of hundreds or even thousands of shares designed to track the overall stock market. For example, you can invest in a fund that tracks the S&P 500, a stock market index that includes the 500 largest companies in the US, including Apple, Microsoft, Amazon, Google, Tesla, and so many more. If you invested $100 in the S&P 500 at the beginning of 1996 and reinvested all of your dividends, you’d have about $1,764. That’s a return on investment of about $1,664% or roughly 10% per year. Or if you’re taking into account inflation, it would be around 7.52% per year. So, instead of putting all of your eggs in Netflix’s basket or Apple’s basket, you can reduce your risk and build a diversified portfolio by investing in an S&P 500 index fund.
The Evolution of Top Companies
If some companies go down, but others go up, you still benefit from the general upward trend of the market. Over time, you’ll own hundreds of businesses across dozens of industries, including tech, energy, healthcare, and finance. And you might look at the S&P 500 and look at what it’s made up of and think, why don’t I just get the best performing companies in there? Invest in the main ones. And for instance, the Magnificent 7. And by that I mean Apple, Microsoft, Amazon, Google, Meta, Tesla, and Nvidia. They have dominated the US stock market in recent years. So I get why you’d want to just focus on those. They are the ones that have had the biggest gains. Why don’t you just go all in on that? But looking at the S&P 500 between 1980 to 2020 shows the biggest companies have changed a lot over time.
Market Bubbles and Global Diversification
Back then the market was dominated by completely different companies. General Electric, Walmart, Exon Mobile, which just goes to show how risky it is to depend on a small number of companies. There is absolutely no guarantee that today’s winners will still be in the lead a decade from now. Looking back even further in the 1960s and early ’70s, American Express, McDonald’s, Kodak, Coca-Cola, they were the big names and investors assumed they would keep growing. But the bubble burst in the mid 1970s with many seeing a huge drop in share price. Kodaks fell by more than 90%. So that’s the point I’m trying to make. You just don’t know which companies are going to be at the top. Something else to keep in mind is that the US economy has its own uncertainties right now and it may make sense to invest in brands from other parts of the world too.
How to Actually Invest
No one knows which country or which company will lead the next decade. So by owning a little bit of everything, you can reduce the risk and have a concrete long-term plan. And now you know what to invest in. How do you actually start? Here’s what you need to do step by step.
Step One
First, you’ll need to pick an investment platform. Wherever you are in the world, this is just the website or the app you’ll use to buy and manage your investments. The key thing to look at here is to make sure is that it’s regulated, reputable, and has low fees because over time the smallest fee difference can massively eat into your returns. Before signing up, have a look at the different types of accounts available on that platform. Some offer general investment accounts where you may have to pay tax on your profits. Others will provide tax efficient accounts such as the stocks and shares ISA in the UK, the TFSA if you’re in Australia or Canada, NISA if you’re in Japan. If you have access to a workplace pension, this might be even more rewarding than a tax efficient account as in many parts of the world your employer will also match your contributions too.
Step Two
So if your employer does match that, look into this option first so your portfolio can grow even quicker. Once your account is open, you’ll need to add some money, usually by bank transfer or by debit card.
Step Three
Then you want to choose your investments. Remember what I said earlier about index funds generally being less risky than individual stocks? As tempting as it may be to build a portfolio with your favorite companies individually, you’ll usually make less money that way than you would with funds. Start with global diversified funds and then as you learn more, you can get more nuanced and increase your returns by adding more structure to your portfolio.
Step Four
Here’s the part that most people overlook. Automation. Instead of trying to pick the perfect moment to invest, you can set up a monthly direct debit. So, a set amount that is invested automatically, 100 a month, 200 every month. By investing small and manageable amounts regularly, you can smooth out the highs and lows of the market. This is known as dollar cost averaging. Some months you buy when prices are high and other months you buy when they’re low. But over time, it tends to average out and most importantly, you remove the temptation to mess about with it.
Risk Management and the Human Factor
Before you dive in, let’s talk about this. What if the market crashes because it’s at an all-time high or the companies you’ve invested in stop growing? Well, the first thing to keep in mind is that if you’ve invested in funds rather than picking individual stocks, you are already well protected. By diversifying your portfolio, you’ll find it much easier to ride out market turbulence, even if some companies fail or the market crashes. That’s why diversifying not only across funds, but also across assets, is so important. And to be honest, the biggest risk for most investors isn’t actually the market itself, it’s themselves. For example, let’s say you see some guy on the news saying that we’re heading for a crash. You might panic and sell your investments only for the expert on the news to be completely wrong. Best case scenario, you sold it for a profit and you could always buy back in. Worst case scenario, you sold it at a loss and you realize that loss and it’ll cost you more money to buy the same investments again.
Taking Confidence in Your First Step
Automating the process stops you from panic selling when things dip or for trying to wait for the right time that never comes. So, if you’ve been thinking of investing, but you haven’t known where to start, I hope this has given you the confidence to take that first step.
