Investing is taking your excess money and letting someone make it grow for you. Of course, you expect you will get back what you gave plus growth minus fees.
Yesterday we looked at why savings in a jar or a bank weren’t going to keep up with the growth of your children. And previously, we discussed the need to have money for emergencies and retirement. (More to come later.)
But, no matter what, you need to invest and get over any of the fears you may have. First off, investing isn’t magic. It can be as simple as buying a house and watching the value grow over time. Or you could purchase open land for your future use or sell it when the value of that land grows. Finally, you can buy rental property and make money by charging rent seasonally or full-time.
But when I think about investing, I think about investing in the stock market.
Simple things you should know before you invest.
- You don’t have to be a mathematician to invest in the stock market safely.
- Investing is not a gamble like going to Las Vegas and playing the one-armed bandits. (There is a reason for that name.)
- There is no better time to invest than right now and regularly after that.
- The vocabulary may seem daunting, but the concepts are simple.
- The market goes up and down, and you never know what tomorrow will bring. But the historical trend has been upward.
Risk and Reward
Investing is all about understanding your goal (the reward) and what risks you are willing to take to achieve them. For example, if your goal is to have enough money saved at 62 to retire and leisurely live until you die, we can figure out how much money you need to save each month to do this.
When you invest in something in the market, there is a chance that you won’t get it back — this is the risk. And similarly, if you want to get a lot back — a high reward, you will need to take more risks.
Investing in the market is about balancing your risk and reward needs.
For example, let’s look at a single company — ENRON. Enron was founded in 1985 and had a meteoric rise up until the 2000s. But in 2001, things began to fall apart, leading to bankruptcy, all workers losing their jobs and their retirement savings. This example is like grandma’s story of not putting all your eggs in one basket.
We will go into how to keep this from happening as we get into more detail about what you can investment opportunities. However, this is also a cautionary tale about ensuring the people and companies you entrust your money to are trustworthy.
Simple and Compound Interest
When you give your money to someone to invest, they agree to pay you interest for using your money.
If I agree to pay you 10% simple interest, then when you give me $100 at the end of year 1, I owe you $110, and at the end of year two, I owe you $120. So for each year you leave your money with me, it grows by $10 per year.
The other way of calculating interest is compound interest. It works like this using the same starting $100. At the end of year one, you earn $10; in the second year, you earn $11; in the third, you earn $12.10.
With simple interest, the amount you earn each year is the same $100 times 10%, no matter how long I keep it. However, with compound interest, the $10 interest you made in the first year becomes part of the calculation for the following year’s interest ($100 + 10) times 10%. So you earn $11 in the second year, which is added to the $110 before we make the following year’s calculation.
So you always want to earn compound interest and pay simple interest.
Tomorrow we will look at how companies get money from us and some simple investments we can make — stocks, bonds, one company vs. mutual funds.