Hey friends, in this post I'll give you a complete breakdown of how to get started with investing your hard-earned cash, what various terms mean in the financial world and how to avoid taking high risks.
So let's say you want to get started with this investing thing. You might have a bit of money saved. It's probably not enough for a house, but you reckon I should probably invest this in something. Maybe you've heard on the news about Tesla or Netflix or Amazon and how, if you'd invested 10 years ago in Tesla then you'd be a millionaire by now or things like that.
But if you're new to the game, this whole investment thing can seem like a really complicated black box. Like, how do you even buy a stock? What even is a stock? Do you just go on tesla.com and buy some Tesla, like, how does it work?
And if you try and look into this, you get all these acronyms being thrown around like ROTH IRA and 401K in America or like ISA or LISA in the UK. And on top of that, there is the anxiety that we all have that I know investing is risky and I don't want to lose all that my money. So in light of all of that, this is the ultimate guide on how to get started with investing. It is the post I wish I would have had five years ago when I first started investing in stocks and shares. And we're gonna cover this by thinking about investing in 10 different bite-size steps.
What happens to my money over time?
So the first one is forgetting about investing completely and just thinking about what happens to my money over time by default. And if you've studied economics, you will know that your money loses its value over time. Thanks to something called inflation. Inflation is generally around about the 2%-2.5% mark. And so that means that every year stuff costs about 2% more than it did the year before. For example, in 1970, in America, a cup of coffee costs 25 cents. But in 2019, that same cup of coffee costs $1.59. That is inflation in action.
And so let's say you've got a thousand dollars in your hand right now. And for the next 10 years, you just stash it under your mattress. And you never look at it again. In 10 years time, your thousand dollars is not gonna be worth a thousand dollars anymore because everything would have increased by 2% every year. So the value of your money will have fallen. And so if you put your thousand dollars under your mattress for 10 years, you will lose money over time. And this is obviously not good.
Even if you put your money in a savings account, like these days, a savings account will give you like 0.2% interest which means your money goes up by 0.2% every year. But because inflation is up by 2% you're still losing money over time. And again, this is not good.
How do we stop our money from losing value over time?
Okay, so that begs the question which is key point number two which is how do we stop our money from losing value over time? And the answer is that if we had hypothetical savings account one that was let's say an interest rate of 2.5% that would match roughly the rate of inflation. So inflation means everything goes up by 2.5% in terms of price. But our money in our savings account also goes up by 2.5% each year. Therefore we're technically not losing money over time.
If you're reading this and you have an issue with the word interest, don't worry stick to it, for now, investment is not the same as interest but we'll come back to that a bit later. But the point here is that we don't just want to not lose money which is what happens at our 2.5% rate. We actually want to make money. And that brings us on to question number three.
How do we actually make money?
Now, let's go back to our hypothetical savings account. If hypothetically, we could have a savings account that was giving us a 10% interest rate this will never happen because that's just way too high. But hypothetically if it did, that means that every year we'd be making 10% of the value of the money in our savings account. So for example, if I were to put a hundred dollars in a savings account right now the next year it would be worth 110. And then the year after it will be 121 because it's 10% of the 110, and then it would be 133. And this would very quickly compound so that in 10 years, my 100 dollars will have become 259 dollars. And if we adjust for inflation that our money is still worth 206 dollars in 10 years. This is pretty good. We have more than doubled our money, by just putting it in this hypothetical 10% interest savings account. And it really doesn't seem like it would do that because 10% feels like a small amount of money. But if you extrapolate 10% over 10 years you actually double your money, which is pretty awesome.
Sadly these hypothetical 10% saving accounts don't really exist, because it's just way too high and real life is not that nice. These days, most savings accounts in the U.S. and I imagine around the rest of the world as well, offer less than a 1% savings rate, which means you're actually still losing money over time. But we do have other options to try. And that is where investments come in.
What is an investment?
So point number four is what is an investment? And the answer is that an investment is something that puts money in your pocket. For example, let's say you buy a house for $100,000 and you want to rent it out to people. There are 2 ways, that's an investment. There are two ways you're making money from it. Firstly, let's say you're charging some rent to the people living in your house. Let's say you're charging them $830 a month. That becomes $10,000 a year. And so every year you're making $10,000 in rental income, which is 10% of what you originally paid for the house. That means that in 10 years time you'll have paid off the $100,000 that you've put in because you're making 10K a year. And beyond that every year you're just making $10,000 in pure profit. So that's pretty good.
But secondly, it's an investment because the value of the house itself would probably rise over time. In general, there is a trend in most developed countries that house prices tend to rise over the long term. And so your house will probably be worth more than $100,000 in 10 years. And in fact in the U.S., historically in the past, some people have said that house prices have doubled every 10 years. So maybe your house is worth close to $200,000. And so you've made money off of the rental income but you've also made money off of the “capital gains”.
But the problem is that buying a house is a little bit annoying. You need to have quite a large amount of money for a deposit. You need to get a mortgage. You need to actually have the house. You just sought out the rental management, rent it out to people, all that kind of stuff. If only there were a way of investing without
a) having a large amount of money to start with
b) without having to put that much effort into managing the assets as well.
And that brings us on to investing in shares. And for me, basically, 100% of my investment portfolio is shares. I have a tiny percentage in Bitcoin and Dogecoin, but I don’t consider it as investment yet. I am just playing with crypto.
What are shares and how do they work?
Therefore number five is what are shares and how do they work? So buying shares probably as close as we're ever gonna get to this magical savings account that just returns some amount of money each year. And the idea is that when you buy a share, you are buying part ownership of the company that you've got the share in.
For example, let's say Apple has a particularly profitable year because lots of people have well iPads and because Apple is feeling kind, they are choosing to pay out a dividend to their shareholders. So for example they might say that they're gonna issue a dividend of a million dollars, and that's gonna be split evenly amongst whoever owns shares in Apple, based on how many shares they own. So for example, if you happen to own 1% of Apple you would get 1% of that dividend that they've issued. So 1% of a million dollars, which is 10,000 dollars obviously no one reading this actually owns 1% of Apple, unless Tim Cook, you're reading, I don't even know if you own that much because that would make you an extremely rich person because Apple is a very valuable company but that's basically how the dividend thing works.
A company decides to issue a dividend as a way of returning some of its profit back to the people who have invested in the company. And therefore you make money through dividends.
The second way of making money from shares is sort of like with houses in that you get the capital gains over time. So for example, let's say you bought 10 shares in Apple in 2010, at the time those shares were selling for $9 each. So you spent $90 on buying 10 shares in Apple. As of May 2021, Apple shares sell for $127. So your 10 shares are now worth $1,270 just by the fact that you only paid $90 for them 10 years ago.
Okay, so now you know about what a share is and how you make money from them. And at this point, you've probably got a few questions like how much money you need to get started or how risky is buying shares in a company. And I promise we're gonna get to that.
How do you buy a share?
Point number six is how the hell do you buy a share? And this is where it can kind of get complicated because it's not as simple as going on apple.com/buy and just buying a share in Apple. It doesn't quite work like that. Instead, you have to go through, what's called a broker. And back in the day, a stockbroker was a physical person usually a dude who you would call on the phone and say "Hey, Bob, I want to place an order for some shares in Apple." And then Bob would types and stuff into his computer or a place like a paper order. And then you would own shares in Apple.
Thankfully these days we don't really have to talk to Bob because there are a lot of online brokers instead. And so you make an account on an online broker and then you can buy shares in a company through that. A bit annoyingly, every different country has its own different brokers that operate in that country. Because to be an online broker in a country you have to abide by a zillion different laws. And so in the UK, the system is different to the U.S. which is different to Canada and Germany, and so on.
I prefer Interactive Brokers. I like their features, their interface, and their fees. But you can choose any other online broker which you want.
How do I decide which shares to buy?
Question number seven is how do I decide which shares to buy? And the easy answer to that is that you actually don't want to figure out which shares to buy. You do not want to buy individual shares. Investing in individual stocks is kind of risky. Like, yes, if you invest in something like Apple, chances are it's gonna be around 10 years from now. But historically there've been quite a few companies that people were like, "Oh my God, this is amazing. This is the thing to invest in." And then that company went bust. So you're automatically exposing yourself to more risk if you're investing in an individual stock. So the advice that most people would give for beginners is that you should not invest in individual stocks.
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What is an index fund?
So there are basically two bits to understand here there's the index bit and the fund bit, let's start with the fund bit. And a fund is basically where investors will pool their money, so multiple investors would invest in the same fund. And then that fund would have a fund manager. And the fund manager decides which companies the fund is gonna invest in.
For example, let's say I was managing a fund and I called it Gringotts, and let's say a hundred people from my audience decided to invest in my Gringotts fund. I as the fund manager can say, okay, the Gringotts fund now that we have a hundred people's money let's say it's 100 million. So everyone's invested 1 million each I've now got 100 million. I'm gonna put 20% of that in Apple, 10% in Facebook, etc. And so you, the investor don't have to worry about this because you trust me and my fund Gringotts to manage your money. And as you know, the fund performs well, because the prices of these stocks and shares increases you get the returns and I take a 1% or 2% management fee.
Now, the index bit refers to a stock market index. And so a stock market index would, for example, be the FTSE 100 which is the hundred biggest companies in the UK, or the S&P 500, which is the 500 biggest companies in the U.S. And if we use the S&P 500, for example, these are the components of the S&P 500. So we said, it's the 500 biggest companies in the U.S.
So number one is Apple and Apple makes up 5.7% of the S&P, Microsoft makes up 5.2%, Amazon makes it 3.9%, Facebook has 2.1%, etc. And essentially we've got these 500 companies if you go all the way down.
So the S&P 500 is an index of the U.S. stock market. And if you look at the performance as a whole of the S&P 500, you get a general idea of how the U.S. economy is going as a whole.
Okay, so we know what a fund is, i.e. a way of pooling money. And we know what the index is, something like the S&P 500, when you combine those, you get an index fund which is a fund that automatically invests in all of the companies in the index. And so with me, for example, basically all of my investments, all of my money is in the S&P 500, which effectively means that 5.7% of my investments are in Apple, 5.2% in Microsoft, 3.9% in Amazon, 2.1% in Facebook and so on.
So why is this good? Well, it's good for a lot of reasons. So firstly index funds are really, really easy to invest in. A big problem that beginners have to investing, it's like, well, how the hell do I know which company to invest in? How do I read a balance sheet? How do I do any of this stuff? If you invest in an index fund, you actually don't have to worry about any of that.
Secondly, index funds give you a decent amount of diversification. There are all sorts of companies in the S&P 500. So you're not entirely reliant on the tech sector or the oil sector or the clothing sector or anything to make the bulk of your money. You are very nicely diversified across all these U.S. companies.
Thirdly, index funds have very low fees. So because it's not a real person who is deciding what to invest in and doing all this research and trying to make loads of money is essentially a computer algorithm that automatically allocates your money based on the components of the index fund. The fees for those are really low. And one of the main things about investing for the long term is that even a slight increase in your fees is gonna massively impact your financial upside. And so for example, an index fund with a 0.1% fee is so much better for you than an actively managed fund where a fund manager is charging you even 1% because the long-term difference between 0.1% fees and a 1% fee is sort of absolutely astronomical over the long term.
And finally, if you look historically and, you know technically historical performance is not the same thing as future performance, but if you look historically very few funds have managed to actually consistently beat the market i.e. outperform the index. And in fact, someone like Warren Buffet famously says that if you gave him a hundred thousand dollars and asked him to invest it right now he would just invest in an index fund, like the S&P 500.
And in fact, in 2008 Warren Buffet challenged the hedge fund industry to try and beat the market. He said that hedge funds are a bit pointless because they charge way too high fees and they don't actually get the sort of returns they claim to get. And so he set up this 10-year bet which this company called Protege Partners LLC accepted, where Buffett said that he was gonna bet that the index fund outperformed the actively managed fund. And he ended up winning that bet and sort of gave lots of money for charity or something like that.
Isn’t investing in the stock market risky?
That is usually the biggest question that people have about investing in stocks. And naturally, there is the anxiety of what if I lose all my money. So let's talk about that now.
So if we take a step back, the only way to lose money in anything is if you buy a thing and then you sell it for less than you actually bought it. Like, let's say you bought a house for $300,000, and then Brexit happens the next day and the house prices plummet. And now your house is only worth $250,000. At that point, if you decide to sell your house, then yes you are losing money and you've lost $50,000.
Equally, the only way to really lose money in stocks is if you buy a stock at a certain price and then you sell it for less than that price. That's a pretty good game. And so the real lesson here is that when you're investing in stocks and shares, and also when you're investing in real estate, these are long-term investments. Ideally, you shouldn't be putting any money into stocks and shares that you need to access within the next five years. And actually, a lot of people would extend that to 10 years.
So realistic, worst-case scenario, yes, investing in the stock market is risky in the short term, but if you're investing in the longterm, the market will always go up and you will always end up making more money in the long run provided you don't have to take money out at inopportune times.
When should you get started?
Okay, so at this point, we've established that investing in stocks is very good and investing in index funds is a relatively safe way of doing this. The next question is usually when should you get started? Like how old do you have to be? Is it ever too soon to start? Is it ever too late to start? And here the answer is pretty simple. And basically, all investment advice agrees with me on this front.
Basically, you should start investing as soon as possible. It doesn't matter how old you are. It doesn't matter how young you are. The earlier you start investing the better. There are three caveats though for like sensible financial advice.
Firstly, you wanna make sure that all of your high interest i.e. credit card debt is paid off because when it comes to compounding even though gains compound, losses compound as well. And so if you've got like a 6% credit card debt that's eating into your bottom line every single month you want to pay that off as soon as possible.
Point number two is that you want to make some sort of emergency fund. And people usually say that your emergency fund should have in cash basically three to six months of living expenses so that if you lose your job or if you're hit with some kind of incredible medical emergency, then you've got money to do that. And you don't have to take money out of your investments.
And caveat number three is that you don't want to put any money into stocks that you think you might need to use in the next three to five years. So let's say you're 24 and you've just landed your first job. And you're thinking of getting a mortgage and buying a house and you need money for the deposit. Do not put that money into the S&P 500 or into any kind of stocks and shares because no one can time the market. And no one knows whether we might you know, there might be a market crash tomorrow. All we know is that in the long term, the stock market goes up, but if you need to buy a house next year there is absolutely no guarantee that that money will still be worth exactly the same or worth more this time next year.
So it provided those two conditions are met. Like firstly, you have no high-interest credit card debt. And secondly, you've already got your emergency fund. And thirdly, you're not planning to gonna have a major expense in the next few years. At that point, absolutely everyone should be investing something into the stock market. And you should start investing as soon as you read this post and hear about investing, you should start investing provided those three conditions that we talked about are met.
How much money do I need to get started with investing?
The next question is usually how much money do I need to get started with investing? And the answer here is again, quite easy, basically, start with whatever you can. You can start with $10 or $100. Basically, you want to start investing as soon as possible. And it doesn't matter if it's a tiny amount of money, to begin with. Firstly, it's useful to invest small amounts of money because compounding is always good. But secondly and more importantly, the sooner you start investing the sooner it becomes a habit.
And so for me, for example, I started investing in 2015. I knew absolutely nothing about it before then, but I really wish I'd started investing in 2009 when I first had my first part-time job because that would have encouraged good financial habits within me. I would have kept aside maybe 10% or 20% from the top line to put into my investments. Secondly, it would have meant that investing became a habit. And so I would have known about the fact that stock market indices exist. I would have done the research. I would have read posts like this, although these weren't really a thing in 2009.
If you have more questions about exactly what to do or anything else about money. Do leave a comment under this post. There's so much to explore in this area, and it's a really fascinating topic but thank you so much for reading this post.
Thank you so much for reading.
Good luck with investing.
Hopefully, you'll read my next post.