If you want to accumulate wealth, and gain financial independence at some point in your life, you need to learn how to start investing your money.
If you build a business and end up making $100,000’s (or Millions) a year, and will not spend most of it, you might be able to get there without investing. But I think learning how to invest your money, even when you start with a little is a great habit to get into.
Over time, the magic of compound interest will kick in, and your wealth will keep growing in multiplying in spite of what you do. And this is what having true financial freedom is all about.
What Is The Magic Of Compound Interest?
Compound interest is interest added to the principal of a deposit or loan so that the added interest also earns interest from then on.
Let’s say you invest $1000 and earn 10% per year. At the end of year 1 you’ll have $1100. ($1000 original investment + 10% which is $100).
However in the 2nd year, you now have $1100 that’s working for you. And 10% of that is going to be $110. So in year number 2 you have $1210.
And so on.
Leave it in there for 30 years, and your $1,000 grew into $17,449.40… without you adding a penny to it.
But what if you added $100 a month to your little investment?
Over 30 years would have put $37,000 into your investment, however you would have $214,842.23 in your account.
Imagine starting this in your early 20’s. And adding a little more and more over the years. This is how people accumulate over a Million Bucks in their investments, without really making a ton of money.
So the next question is…
Where To Start Investing?
There are several options for you to start investing and making your money grow:
Which is basically putting your money in a savings account or a CD, and let it sit there collecting 1% interest. Considering the inflation is around 4% (don’t believe what the government says because they don’t include all the prices of consumer goods.)
Bank accounts are not meant for investing. They are just what they’re called – savings. Money that you always have instant access to anytime you need it, but you earn nothing on it.
So if banks won’t do it, what’s next?
You have a few choices.
Bonds are “fixed-income” securities. It’s a way for a company or the government to raise money (by selling a bond to you) and pay interest to the bondholders (you).
When you buy a bond, you are basically loaning your money. If you buy a government bond, you’re loaning your money to the government. If you buy a corporate bond, you’re loaning your money to a company.
The risks are:
Interest-rate fluctuations – when interest rates rise, the price of your bond will go down. And vice-versa. If you’re getting a good % on your bond, the price of the bond will not matter much in the long run, because you’re getting paid regular interest on your investment.
Bankruptcy – however if the company goes out of business, and they have no funds left to pay off their creditors, you will lose. This is rare with big corporations, but the risk is there. For that, you’re getting a higher rate of return than with a bank.
If you invest in government bonds (aka US Treasuries), they are backed by the government. These are probably the safest type of investments. The interest rate they pay are lower than corporate bonds, but the risk is minimal as well.
Typically with higher returns comes higher risk.
Than we have stocks. Which is buying individual shares of a company, and owning a little (or a big) piece of it. With stocks you get to participate in any dividends paid out to shareholders, ans well as the appreciation of share prices.
If the company does well and keeps growing, your shares will keep growing.
In 2004, when Google issued it’s shares, they were $85. Today, on the day I’m writing this they are at $748.40. There was a stock split, so it’s a little more complicated than this, but for the sake of simplicity, let’s just say your money grew 9 fold. (It’s actually more than that because of the split)
In fact Wall Street Journal showed that if you invested $10,000 in Google on the day of it’s IPO (the day it started trading stocks) on August 19, 2004… exactly 10 years later, on August 19, 2014 you would have $139,458.82 Not too shabby, huh?
Stocks are very lucrative, if you invest in the right companies. But the risk is you go down with the ship if the company goes belly up.
Which is why for most people, with little money to invest it’s probably NOT a good idea to buy a single stock.
Buying stocks is pretty simple. You can do it online with discount broker.
This is kind of obvious. You’re buying ownership in a land, a building, an apartment complex or some other real property.
Historically, real estate has not outperformed stocks. But, the risk is much less.
The challenge with real estate you have to know how to invest in it, and it usually requires some money. It’s not like you can go and invest $1,000 in buying a property.
This is probably the best investment for most people. Mutual Funds are a way for you to have your money professionally managed in a pool with other investors. The entire “fund” is split up and is invested in different companies. Typically, most mutual funds don’t invest more than 1% of the entire fund in any one company. This diversification spreads your risk, and allows you to participate in the growth of many different companies.
Yes, there are fees for that. The money managers who manage the fund typically charge between 1-2% of the entire fund’s assets for management and operations. So you’re not paying them out of your pocket, but it does eat into your investment returns.
However keep in mind that your money is being managed by a team of analysts and traders. The collective power of having many investors in one fund gives you the leverage you need to have it professional managed, and have ownership in over a hundred different stocks. Something that’s impossible to do on your own.
By the way, there are funds that invest in stocks, bonds and real estate. So you can easily diversify among different types of investments, as well as different number of companies you’re investing in.
So the risk is lower, but the upside potential is very good.
Over the long-term, I believe mutual funds are the way to go for most people.
And there are many funds which will allow you to start with as little as $50 per month, which makes it a very affordable way to start investing your money and building your wealth even if you’re on tight budget.
Just like with stocks, any online discount broker will give the option of 5,000+ different funds you can access to start investing.
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