Hey, girl! I’m so glad you’re here! Congratulations on taking the first and most important step toward starting to invest.
Many women tell me that they want to start investing, but they feel overwhelmed, scared, and unsure where to begin.
This post will break down the high-level basics of investing: what is investing and why it’s important; what’s the difference between saving and investing; what are the main types of investments out there; and what is an index fund. Let’s dive in.
What is investing, and why it’s important
Investing is using your money to buy investments that will hopefully increase in value over time. In contrast, trading (or speculating) is buying or selling a security to generate a quick profit by taking advantage of short-term market fluctuations. I do not do trading, so when I talk about investing, I mean buying securities for the long term.
Why should you be investing? Because it is your best shot at growing your wealth and reaching your financial goals over the long term. According to Warren Buffett: “Stock market is not just for the rich. It is a way to get rich.”
Historically, the stock market increased by an average of 9.8% a year between 1928 and 2020! Let’s look at a hypothetical example. If you invested just $1 in 1928 and kept adding $1 a month to your investment portfolio, you would have $671,156 in your account today! That is mind-blowing!
If you look at the graph below, the value of your portfolio did not increase linearly. It took some time for a snowball effect to make a difference.
In finance, it’s called the power of compound interest. The longer your money is invested, the larger your investment pie grows. That’s why it is so important to start investing as soon as possible! But don’t be discouraged if you are new to investing. There is no better time to start than now.
Investing vs. saving
How is investing different from saving? With saving, you put your money into a bank account where it sits, safe and sound until you withdraw it at any time. Cash in your savings account earns 0.09% on average, according to FDIC.
Investing is different. When you invest, you are using your money to buy securities that might go up or down in value. With investing, you are taking on more risk. It is possible to lose money with investing. But historically speaking, if you’re investing for many years, that hasn’t been very likely.
Here is a critical personal finance rule: if you need the money in the next 1-2 years (your emergency fund, down payment for a home, etc.), keep it in the savings account. You cannot afford to risk this money in the short term.
Your biggest risk in the long term – inflation
Let’s talk about INFLATION. Inflation is a general increase in prices and fall in the purchasing power of money.
Inflation is the reason why investing is not optional. A conservative 2% annual inflation will destroy HALF of your money over 30 years. Are you paying attention now?
Let’s assume you have $10,000 and you plan to use it in 30 years. You have a couple of options:
Hide it under your mattress
If you keep your money under your bed, it will lose purchasing power in 30 years. Assuming 2% annual inflation, your $10,000 will be worth only $5,521! You lose almost half of it! Not cool.
Put it in a savings account
If you played it safe and parked your money in an average savings account for 30 years, you would theoretically end up with $10,274. Whoa! A profit of $274 over 30 years! But wait. I said “theoretically” because if we consider 2% inflation, your money will be worth only $5,672…you lose almost half of it.
Let’s assume you did your research and opened a high-yielding savings account with a 1.7% rate of return (the highest I could find at the moment). Your $10k will turn into $16,582 in 30 years, but in reality, it will be only worth $9,154 if we account for inflation. You’re losing money again!
Invest your money
You invested your money in the diversified portfolio of low-cost index funds. Over 30 years, your $10k will grow into $43,219 in your conservative portfolio earning 5% a year or $174,494 if you use the historical average return of 10%! If we adjust for 2% annual inflation, your $10,000 will be worth $23,860 and $96,333 respectively! Now we’re talking!
Now let’s go crazy and imagine that you added $100 a month to your portfolio for 30 years. A little over $3 a day. Small change. Big difference! A portfolio earning 5% a year will turn into $126,936 on paper or $70,076 after inflation! If your money earns 10% a year, your $10k will be worth $391,626 or $216,205 in real terms! Investing is how you get wealthy!
Main types of investments
There are three major categories of investments – stocks, bonds, and alternatives.
Stocks (shares or equity)
When you own a stock, you own a small piece of that business. Each share of stock represents a proportional stake in the company’s assets and profits.
Stocks go up and down in value for many reasons, such as expectations of a company’s performance and its actual results, the state of the economy, market liquidity, news about the company or industry, etc.
Stocks are usually a good hedge (or protection) against inflation over the long term because companies can pass on the increase in prices to the consumer.
Bonds (fixed income)
A bond is a loan you make to a government or a company in exchange for regular interest payments (called coupons). The loan is paid back by a specific date (maturity date).
Most bonds don’t protect you against inflation because the interest payments you receive and the amount of principal is agreed upon in advance.
Alternatives are anything that is not stocks or bonds—for example, real estate, commodities, art, or even cryptocurrencies.
Ideally, you should try to have all three types of investments in your portfolio.
Also, you want to have different types of stocks, different types of bonds, and various types of alternatives. Combining different types of investments in your portfolio is called being diversified.
Nobody knows which investments will perform well and which ones will do poorly; that’s why you need to diversify.
There are a few ways you might invest in stocks, bonds, and alternatives. You could purchase individual securities, or you could buy index funds.
An index fund is like a basket of securities. It is a type of mutual fund or exchange-traded fund that tracks the performance of a specific index or a market.
For example, if the index tracks the S&P 500, the fund buys shares from every company listed on the index. In turn, an investor can purchase shares of the index fund, whose value will mirror the gains and losses of the index being tracked.
Buying individual shares of all 500 companies could be costly, but buying an index fund tracking the S&P 500 makes investing affordable for the individual investor.
Index investing is a passive investment strategy. Instead of trying to outperform the market by picking individual stocks or timing it, passive investors simply look to match the market returns.
There you have it! We’ve discussed what investing is and why it’s vital for growing your wealth over the long term. We’ve looked at the difference between saving and investing. We’ve talked about the main types of investments out there and what is an index fund.
If you’re ready to take the next step, I recommend you download our free Ultimate Guide to Investing. It spells out five simple, timeless principles for investing success – a must-know for any intelligent investor.