Investment 101: Uncover the Why, When, What and How of Smart Investing

Do you have some extra money and you hear everybody talking about investing. You are thinking, should I do it too? But you have no idea how to start? You think its too risky? Stop searching, take a cup of coffee, watch and relax. Here I will tell you why you should invest, what you need to do and how you should get started.

Why Invest?

First of all, your money loses value if you don’t do anything with it. Think about this for a second.

Let’s explain this concept with an example:

A Big Mac in 2000 was around 2.50 USD in the United States, currently it stands at 5.36 USD.

This means if you had 5 USD in 2000 and you would not have done anything with it for 23 years, you would have been able to buy two Big Macs in 2000, but now you cannot even buy one...

This loss of purchasing power is called inflation…

So, this means we must do something with our money if we want to keep our purchasing power. Let’s see what would have happened if we had put the money of one Big Mac (2.50) in a deposit of let’s say 3%.

If in the year 2000, you put 2.50 USD in a deposit account with a rate of 3% for 23 years you get a result of 4.93 USD in 2023. This means that putting your money in a savings account is not enough to buy one Big Mac after 23 years

For this reason, we need to INVEST, because investing on average will give you a return higher than your savings account. Please note that I’m saying “on average” as no investment return is guaranteed.

Let’s continue the same example. Investing the 2.50 USD at a historical rate of 6.71% (return of the S&P500 since 2000). The result of 23 years investing at 6.71% will get you 11.13 USD! With this you can buy two Big Macs even!

Why Start Now?

So now that we have cleared up the simple why of investing, now we arrive at the next question, why should you start now?

The reason is very straightforward, and it’s called compounding!

As you might know compounding is also called interest on interest. Let’s have a look at an example.

Mr. A puts 100.000 USD in his bank account in the year 2000 and earns 5% on a yearly basis, meaning 5.000 USD per year. At the end of each year, he takes it out and goes on holiday to enjoy himself.

Mrs. A also puts 100.000 USD in her bank account in 2000 and earns the same 5%. But instead of going on a holiday, she puts the interest back into the bank account. For this reason, she gets 5% interest on the interest again, which is called compounding.

What is the situation 23 years later?

By the end of 2023, Mr. A still has 100.000 USD in his bank account (while having had some nice holidays of course).

However, Mrs. A now has 322.510 USD! She tripled her money…

That’s the power of compounding… The longer you do it, the stronger the effect. Therefore, the younger you start, the better! So, start now!

Before Starting to Invest

So, now we know that we must invest, there are three things we must get in order before we start.

1) Make sure you are out of debt. You don’t want to invest money while you have a high interest paying debt on the side unless the interest rate on your debt is really low.

2) Have an emergency fund of at least 3-6 months. This is needed because if you have an unexpected big payment coming up (your car breaks down or any other big expense), we don’t want you to take out the money from your investing jar.

3) Don’t withdraw your investment money for the coming 3-5 years. This is part of the psychological side of investing. If you need your money quickly you will start to take unnecessary risks, which is something you should never do.

After having that straightened out, let’s get to the basics of how to invest.

How to Start Investing

Depending on which country you are in, you will need to open a brokerage account at a broker. (In jargon this is called a brokerage house). A broker is a firm (not necessarily a bank) that facilitates you and the investment, it buys the investment for you. It then keeps the investment in a safe house at a firm that is called a custodian (this is often a bank).

Brokers

There are three different types of brokers:

1) Full service brokerages: These firms provide all their services to you, from buying stocks, crypto, tax advice, investment advisory and equity research. You can get anything you want, but in return the fees are often higher.

2) Discount brokerages: They only perform the function of buying and selling of stocks for you. Because they specialize in this, their commission is lower than full service brokerages.

3) Online brokerages: A “newer” form of brokerage, which only uses the internet to execute transactions, often you won’t have a person to call as with traditional brokers. Here the advantages are the speed of execution, availability of investment products and lower commissions.

If you want to start, I would recommend an online broker first, so you can try out everything in your own time.

There is also a branch called roboadvisory, if you haven’t heard of the term yet, it’s an online service where you provide your investment requirements and constraints (for example, every month put 100 USD aside and you are willing to take only very low risk). According to these parameters the AI that roboadvisory uses determines your asset allocation (where you invest and how much).

Now you are all ready and set to start, but what are you going to invest in?

What to Invest in?

Asset classes:

Investment products are often divided into asset classes.

The most well-known is the stock market, also called equity, here you buy shares or an ownership stake of a specific company. You have real estate, which is basically buying a house and renting it out or waiting for it to increase in price. You have fixed income, which consist mainly of bonds. Here you basically lend money to the entity that issues the bond, where you get a fixed return.

There are many more like crypto, private equity, commodities, venture capital and more, but they will be covered in later videos.

Each of these 3 main asset classes have different characteristics, whereas a bond has a fixed return and lower risk, stocks have higher risk and a higher return. Real estate and bonds need a higher amount of entry (you can’t buy a 100 USD real estate or bond), while you don’t need a lot to buy stocks. Each investment has its own characteristics.

To give you a better idea of different asset classes, here you can find the return of major asset classes since the great Depression.

Active vs Passive Investing

Besides the type of asset class, you also need to think about whether you want to be actively involved in the buying and selling or not. This means do you want to either research each stock, bond or real estate, daily or weekly? Or do you want to buy stocks and forget about them for a longer period, so only checking every 3 or 6 months let’s say.

In general, active investing takes a lot of work and according to research, most of the actively managed investments do not outperform passive investments. Of course, there are exceptions to the rule.

If you are more interested in the passive investment side then you can best use index funds. These are funds where professional managers try to replicate an index, like the S&P500. They invest in each stock in the same proportion as the index. With this you have ownership of all the stocks in the index you choose. So, by buying, let’s say the S&P 500 index fund, you are always investing in the S&P500 without doing anything. Index funds are well known for their very low commissions. Two examples of index funds are: SPDR S&P 500 ETF and iShares Core S&P 500. You can also have index funds for real estate and fixed income.

Other Considerations:

Finally, there are some other things to consider.

- Dividend stocks vs growth stocks: Dividend stocks are stocks that pay you a certain percentage of their profit each year, called dividend. Some examples are the stocks Verizon (6% dividend per year), Starwood Property (Hilton hotel chain – 10% dividend) and Intel (5.45% dividend)

- If you don’t know yourself yet and how much risk you are willing to take, it might be a good idea to take a risk profile test. You can find some investor questionnaires on Vanguard or other websites. Reach out to me and I can send you some.

- Fees are important! Don’t overlook the fees. Different investments will have different commissions, while 1 or 2% doesn’t seem like much, with compounding it will come to a significant amount later. Make sure you are not paying too many commissions!

- Isn’t investing risky? Many people have said, “Don’t invest in stocks, it’s too risky. Instead of investing in real estate, its much safer”. Well as a matter of fact you are buying a house for the long term and you expect the house to go up in value in the long term. Many people buy stocks with a more short-term view, so comparing them isn’t the right thing to do. Nobody sells their house in 2 weeks if the price has gone up! If you look at the long-term performance of stocks, they outperform any asset class. So the lesson here is, don’t rush into anything before you know the characteristics of each asset class

So here you have it! These are the basics of how to start investing. This is just the tip of the iceberg, there is a wealth of information to go through. Take it easy and step by step but start early! It’s never too late. You will make mistakes along the way, but that’s the best way to learn! If you’re not sure about something, feel free to send me a message.

Feel free to click the link below where we break it down for you in our YouTube video:

https://www.youtube.com/watch?v=3Ii983I5zrk