Investing: making your money work for you.
While the basic ideas behind investing are easy to understand successful investing is far harder to figure out for the average person. It actually seems like some people have a talent for it while others struggle. To start off, we need to understand what investments are, and why and when it makes sense to invest your money.
What are Investments?
Investments are places/instruments to put savings that will likely grow at a faster rate than inflation. They can actually be simple cash in a bank account or they can be a stock in a start-up company that hopefully goes through the roof.
Investments come in a vast array of forms but the average person will only need to get used to a few of them. The basic versions are stocks or term deposits such as bonds that make a certain % of interest per term. Both term deposits and stocks can be bought in bundles as ETFs or Mutual Funds. The advantage here is that the negative effect of decreasing bonds or stocks within the bundle can be buffered by the other stocks or bonds of the bundle. It goes without saying that the reverse is true as well: Exceptionally successful bonds are influenced by those bonds or stocks within the bundle that don't do so well at the time.
In general, this form of investing is considered a safer method than buying a single stock which may go down in value considerably. Learn more about risk assessment of investments here.
Why do we need investments?
Investments are a necessity of life for any successful budgeter. Once some savings have accumulated, the best way to make more money is to invest. Without investing, savings are likely to lose ground to inflation which means your funds lose buying power. We all know that $20 does not buy you as many products or services as $20 bought you in 1990.
Investments are a way to make funds grow faster than basic bank accounts that make interest at rates lower than inflation. Investments can be placed on a spectrum between low levels of risk and high levels of return on your investment. The higher the risk the higher your expected return and vice versa. Therefore, investments do carry risks that could lower the value of the investment but they can also make savings grow much faster if the investment grows at a reasonable historical rate.
The major stock markets grow at an average of 7-8% per annum over the long run. While 7-8% is the average for the major stock exchanges all other investments might develop at their own pace (as they are not the actual stock market). Analysts have found out, however, that they should be able to come close to that mark over the long run. Find out more about how to get high returns on your investments here.
When to start investing and what to keep in mind
It will likely be a year or two before an investment other than bonds, GICs or other safe investments should be made, simply because your saved amount has to reach a certain critical threshold before it makes sense to invest. In the mean-time, it is advisable to learn about investing constantly. While learning about investing save up your usual funds. Don't wait until you've learned, save while learning.
As a next step, go to a broker or planner and talk to them. When you feel like you can talk to them knowledgeably you are probably ready to take the first steps in investing. YPB recommends starting with one safe type of investment like an ETF (Exchange Traded Fund). Remember to check out what you are saving for and how long it will take to make sure you are making the right investment.
Most people do better with low-cost index funds (ETFs) and passive allocation mutual funds. It is a bit of the old story about the tortoise and the hare. Slow but steady wins the race. ETFs and mutual funds are slower, steadier and safer. Individual stocks are more volatile and therefore need more experience around buying and selling them to be successful. When just starting out stocks should only be bought if somehow there is some extra cash saved up. If the stock does poorly it will not hurt your overall portfolio. If you want to invest in stocks it is extremely important that only a small percent of your portfolio is used until the portfolio is worth a lot of money.
Make sure that all of your initial investments don't have a large cost or annual costs that can eat away at your investments. It is amazing how fees can lower your savings. Check any fee schedule before actually buying an investment.
Where to Invest
- Banks: have their own branches or online access. They are limited in the nature of investments they can provide you with.
- Investment firms: use brokers that help you with your investments and charge a hefty price.
- Online Brokers: are mainly for people that like to DIY. They sell the full array of investments.
- Robo-advisors: are companies that usually pick some of the best ETFs and MFs in the business from other companies and simplify the investing concept by selling the ETF's and MFs that fit the customer's criteria
Each company has its product portfolio and cost structure. Pay attention to the costs each company has. DIY methods are usually very inexpensive while using a broker or planner may cost a lot. MF can have upfront as well as backend fees. ETFs and stocks have simple costs when doing it our self. With brokers ETFs, MFs and stocks will have basic costs for buying them but when selling the cost is a minimum plus the broker/planner may take a percent of your profit. In each case, the customer needs to be very diligent and add on the cost to figure out the value of the product and the profit.
How to get 7-8% long term (10 years+)
There is no way to guarantee any profit or loss in investing but the market has done nothing but go up for the past two centuries. But it is also known for its major crashes. Therefore, it is critical to understand that investing is a long-term concept for the average person. It is near impossible to simply start investing and always increase your value. There will be ups and downs. In order to get a decent historical average, it usually takes over a decade of investing. The other aspect that works well is to dollar cost average. That means putting in some funds on a regular basis (like once a month) and when enough funds accrue to buy a product then buy it. Don't worry about the ups and downs, just buy it. The only problem that remains is hoping that the market is down when you need the funds. That is something that no one can figure out. That is why some cash should always be kept on hand and maybe some very safe mutual funds or ETFs (they don't crash as much as stocks or at least not as fast because they are diversified. Another issue is to make sure that there is some amount of diversification. That way if a segment of the market crashes it won't devalue your portfolio all at once. Buy a variety of products.
Savings time-lines
- saving for something that should take less than 5 years: keep most of your funds in cash, bond type products, or a product that doesn't crash badly. Some ETFs and MFs are extremely safe due to their structure (diversification).
- saving of 5-10 years: investing should take place in order to get better returns on your funds - keep about 50% and 50% in very safe MFs or ETFs.
- savings over 10 years: will require investing in order to get a decent return on your savings - let the market make your savings grow. Once again though, figure out your risk level and invest based on that level. Read up in websites like Investopedia about risk levels before buying individual stocks or other investment products.
Learning about investing
A simple way to learn more about investing is to start by checking out your bank, broker or planner. Then also check out +++Investopedia+++ which has all sorts of information as well as test portfolios. They are a great way to find out your own skill level without losing a lot of money.
In a nutshell
Your Budget Plan feels that learning is a necessity to investing. While saving up a pot to start with, read, learn, and test. Once your initial pot is created then it is best to start with the simplest, safest, and consistently successful performing type of investment. That is an ETF or mutual fund that mirrors the major stock indices in the world. A fund following the Dow Jones Industrial Average or the S&P 500 is standard in America. Europe has several major indices as does Canada and Australia.
History tells us that the major indices average 7-8% over the long haul. Therefore, it is smart to buy these types of investments to start with. This is also called a passive approach. It is passive because no one has to think what stocks to buy. The fund managers simply buy the stocks that make up the indices. This also means the manager of the fund doesn't do much work therefore the costs are minimal. It is also simple to add funds to the ETF or mutual fund by setting up an automatic account. Your funds are automatically put into the fund, the client receives more shares in the fund and any dividends are reinvested in the fund.
*Your Budget Plan is not a financial institution. All our information is from experience and personal research only.