Why Should I Learn About Investing?
When it comes to giving financial guidance to couples, advisors encounter the same dynamic again and again: One spouse is almost always the champion of the family’s finances. This person follows the markets, reads the Wall Street Journal, and has either invested the family’s funds or has worked directly with an advisor. This video series is for the other spouse. The other spouse would like to know more about the family’s finances, but is afraid of saying something foolish. If the couple meets with an advisor, this spouse remains quiet. Does that sound like you? If so, you’ll enjoy these short videos. We’ll start with the fundamentals — what is investing? — and move up from there. A quick warning to investment geeks: These videos are not for you. This is an introduction, and much of the material has been simplified for beginners. With that said, we hope you find the series both entertaining and informative. And don’t worry — there are no tests or grades. You get an A for just showing up.
The Difference Between Saving, Investing, and Speculating
Every successful investor must begin by understanding the difference between saving, investing, and speculating. If you get those confused, you run the risk of losing a lot of money. Let’s start with saving… Saving can be defined as the process of setting money aside in order to make a purchase a short time in the future — typically, under 3 years. The most important element when it comes to saving is the safety of your money. You don’t want the value of your savings to fluctuate, because you’ll need all of it to make your purchase. There are several options available to help you save money: savings accounts, money market accounts, and certificates of deposit, for example. Unfortunately, as a trade-off for protecting your money, saving typically pays interest at a rate that is just a bit higher than inflation. If you want to earn more than that, you’ll have to look to investing. Unlike saving, investing is a long term process. It often involves committing a portion of your money to owning a share of a business, with the expectation that you’ll receive a higher return than inflation. The most important factor in investing is the growth of your money. And there are many ways to invest, with stocks, bonds, and real estate being the most popular. However, once again there’s a trade-off. While investing typically offers better returns than saving, it also carries more risk, as the value of your investment bounces up and down — at least, when looked at in the short term. To be a successful investor, you must invest your money for at least 3 years. That’s because over longer periods, the value of your money will appreciate enough so that even if the value of your investment falls over a short period of time, it will still be higher at the end of the period than it would have been if your money had been sitting in a savings account. But what if you need to grow your money quickly? That’s where speculating comes in. Speculating involves putting your money at risk with the hope that you will earn a high return in a short period of time. Day trading is a good example of speculating, where stock trades are opened and closed in a period of minutes or hours. Speculators can win big, but they can also lose everything. So to sum up: Save to protect your money. Invest to grow your money. Speculate to gamble your money.
What is Inflation? (And Why is it Bad?)
Dave has a problem: He has his eyes on a beautiful 1978 Ford Pinto — barely used. It’s a bargain for $24,000. In a world without inflation, Dave could simply save $8,000 a year for three years and he would have exactly what he needs to buy his dream car. But what happens when we add 3% annual inflation — the historical average in the U.S.? The price of the car jumped from $24,000 to over $26,000 — an increase of more than $2000! And that’s the curse of inflation: Your money is worth less in the future. Take a common household item like a table. In 1913, the price of a table was $20. Today, that same table would cost you $470. That’s an increase of 2,253%! So if your assets are in danger of being overcome by the rapidly rising waters of inflation, what can you do? How can you get ahead? You have to grow your assets faster than the rate of inflation. You have to outpace it. But if that’s true, then bonds, savings accounts, and money markets are out, because their rate of growth is just too small. Inflation will gobble it up. If you want to grow your assets faster than inflation, you’ll need to invest in stock or real estate. Both have a track record of beating inflation. For example, historically, stock has earned a premium of 6.6% over inflation, over time. So, if you were to invest $1,000 today and earned 6.6% each year, in 30 years, you’d have $6,803 — and that’s after inflation. Or better yet, imagine that you invested $1,000 each year over that same period. After 30 years, your cumulative investment would have grown to $87,928 after inflation. And that should be more than enough to buy the Ford Pinto of the future.
What is Investment Risk?
Successful investing is all about balancing risk with return. The return part seems easy enough… we all want to see the value of our investments go up. However, investment risk is a bit more complicated than you might think. Let’s take a look at what investors mean by risk, and how you should consider it when investing your money. According to the dictionary, risk is “exposure to the chance of injury or loss,” and investors would agree. When we invest our money in stocks, real estate, or other assets, we don’t want to lose it. So the first and most obvious investment risk is the possibility that we could lose all our money. The good news is that if you follow the basic rules of investing that you’ll learn in this video series, the probability of losing all of your money is virtually zero. The bad news is that you’ll still get nervous when you see the value of your investments move up and down each day. This fluctuation in prices is called “volatility.” As the price movements get more extreme, the volatility of your investment is said to increase. When the up and down movements get less extreme, volatility is said to decrease. While investment volatility can be scary, it can also lead to significant investment opportunities. Here’s how that works… When prices start to fall and volatility is increasing in the downward direction, some investors panic. It feels to them like their money is running down the drain, and that if they don’t sell now, they’ll end up losing everything. This is the ideal moment to grab investments at prices lower than they’re actually worth. In short, volatility gives you the chance to buy investments on sale from terrified investors who are fleeing the market. This is why it’s so important to keep your emotions in check when you make investment decisions. Panic can be very costly. So now you know the wise investor’s secret: Volatility equals opportunity, as long as you follow the rules for building strong portfolios.