If you’re lucky enough to have previously started investing in your teens consider yourself way ahead of the curve. For the majority of people Investing 101 is for you. Most of us start investing in our mid to late 20s, but for those that start as early as possible can set themselves up for an incredibly lucrative future.
Where should you start for Investing 101?
There are a couple of places that will have the largest impact on your net worth. If, let’s say you have a summer job and you’re making $5,000-$10,000 a summer or you’re working throughout the year then opening an investment account is a great place to start.
For us, saving anyway in any type of account is great. While we like all accounts for different reasons, we like the Roth IRA the most when you’re young. A Roth IRA is like a bank account with different advantages. It enables you to save money that you’ve already paid taxes on and those savings grow tax free until you turn age 59.5 penalty free. Now we love the Roth IRA because typically when you’re young your income is fairly low so taking advantage of low tax rates is a great strategy. Since you’ll be in the lowest tax bracket in 2020 (things may change in 2021) then paying taxes now for your money to grow tax free for multiple decades can have a profound impact on your wealth.
The reason is called compounding growth. Let’s say you make it very easy on yourself and just buy into the SP500. It’s an index that tracks the 500 largest companies and you can invest in all of them using one investment vehicle.
Let’s break Investing 101 down.
A stock is a way to own a part of a company.
An Exchange Traded Fund (ETF) is a basket of stocks that give investors exposure to typically hundreds of companies. Since you cannot buy an index like the Dow Jones, SP500, or Nasdaq (different indices) directly, you have to buy a vehicle that gives you exposure to them. That vehicle can be a ETF, which is usually a less expensive and passively managed investing vehicle when compared to a Mutual Fund.
A Mutual Fund (MF) is a basket of stocks just like an ETF that is more actively managed and usually more expensive way to gain exposure to the same stocks. The difference being whether or not you think someone can actively outperform the index (MF) or you just want general exposure to the index (ETF). You can argue both sides so do what makes you feel comfortable. ETFs and MFs have different tax obligations but this isn’t as big of a concern until you’re in higher tax brackets.
If picking stocks is difficult, you aren’t interested in it, or you just want things to be more simple, investing in ETFs is an incredible way to bring you long term wealth.
ETFs and MFs typically pay what’s called a dividend. This dividend is like a thank you from the company for investing in that company. It’s a cash payment to you, typically quarterly, that you can use to reinvest back into your ETF or MF, a new stock, or whatever else.
Think about your investment portfolio like a business. This is the core to Investing 101. Your business takes money and hopefully makes you money. When you make more money you either spend it on yourself or put it back into the company. When you put it back into the company the company grows and makes you more and more money over time. This is a great way to think about investing in an ETF or MF. Every quarter, without you having to work at all, your fund is paying you and you can reinvest that money to grow your portfolio more and more.
Wealth isn’t created overnight. The secret to wealth is long term saving and investing. Hence, those that have time on their side have the greatest ability to accumulate wealth.
So what else should you be thinking about?
After investing in yourself first, think about where else you spend your money. We wrote an article on the difference between erosive and accretive debt. If you find yourself buying lots of clothes, expensive shoes, fancy gadgets, and new cars then you’re not investing in your “portfolio business”. When you stop investing in your business you stop growing. Each time you do this the effect is compounded.
For example, if you invested $1,000 and $100 monthly for 40 years at 9% interest rate (average gain of the SP500) you would have ~$436,000 at the end. But let’s say you invested $1,000 upfront and only $50 monthly over the same time period and same interest rate, you’d have ~$234,000! That is a massive difference for only $50. That could be one meal out for you and your significant other, one new shirt you liked that you didn’t need, a car payment on a new car because you didn’t want a used car.