The 5 Basics of Investing That Everyone Should Know

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Basics of InvestingAre you curious about investing, but are afraid that you don’t know enough? Or maybe you’re terrified of losing money? You’re not alone for sure. I have a job in finance and I own and operate this personal finance website, and I still often feel like I don’t know enough!

But the truth is that absolutely no one knows everything there is to know about the world of investments – even those that do it every day. But each day another millionaire is made because they learned a few simple investment basics many years ago. And now, it’s your turn.

The 5 Basics of Investing

Here’s my disclaimer… I am not an investment professional nor do I claim to be. BUT, in the past six years I have turned my non-existent retirement account from zero dollars to over $70,000 with positive earnings in every year.

These are the principles I live by, and it’s what I think every investor should know before they start trading.

1) The most important part of investing is putting money in

It’s easy to get caught up in the numbers and the hype of what’s hot in the market, but the truth is that the greatest contributor of your investment success is simply putting money in! It’s the first of the five basics of investing.

I’ve got a friend that always brags about earning 23% on his investments. It sounds pretty awesome until you catch wind of how little money he’s actually investing.

Do you know what 23% of $1,000 is? $230. Practically nothing.

Do you know what 8% of $100,000 is? $8,000.

Last I checked, $8,000 beats $230 every time. If you want to succeed with your investments, load up your investment accounts!

2) You are actually buying ownership in the companies

When you’re buying a stock, you are actually becoming a part owner of the company.

What if your friend walked up to you and asked you to invest $10,000 in their new restaurant idea? Would you just hand over the cash and hope for the best? Of course not! You’d ask questions like, “Where will your restaurant be located? What type of food will you serve? Do you have any experience in the restaurant industry? What are your projected returns in the first five years?”

All valid questions… and they’re not far from the questions you should be asking about your future stock purchases.

Forget about all the complex financial analysis that probably makes no sense to you. Keep it simple and ask questions like this:

  • Do I believe in the product/service that they offer?
  • Is this company growing? Where will it be in 10 years?
  • Who is leading the company? Do they have a good track record?
  • Is the industry growing?

Again, investing doesn’t have to be complicated. For the most part, it’s just common sense stuff. If the company is run well, has quality products, and is in a growing industry, then chances are they’ll do well!

3) Stay consistent

I’ve seen it way too many times… When the market goes up, people wait. Then it goes up again and they wait a little longer, just to be safe. The market goes up again, and okay, now the people buy in and hope for years and years of great returns!

But then something happens… The market actually goes down! These people now don’t want to sell because then they’d take a loss on their investment, so they wait for a bit. Then the market goes down again! They wait. Again, the market continues to tank and the normal investor just can’t take it anymore! They sell and are left with half of what they started investing with in the first place.

Unfortunately, the comical story above is all too real for too many people. They’re so risk averse that they hesitate and second-guess, and then end up losing money in the market!

The third of the basics of investing? Consistency.

The stock market goes up, then down, then back up again… It’s best to just keep putting money in all along the way. Set up a draw from your paycheck, contribute a certain amount of money each week, and then half-ignore what the market’s doing so you aren’t inclined to over-react. This might sound like the hope-and-pray method, but it’s actually much more than that. Wise investors call this practice “dollar cost averaging“.

4) Know the basic lingo

As I said in the intro, many people don’t invest because they’re intimidated by what they don’t understand, so let’s talk about the basic lingo for a second.

Stocks – If you buy a stock, you’re buying a share of the company (part owner if you will). When the company is profitable and increases in value, you earn money because each share will also increase.

Bonds – With a bond, you’re essentially buying debt from the government or a corporation, with their promise to pay you back with interest. Bonds are often the safer play, but they have historically earned less than stocks over time.

Mutual Funds – These funds were set up a few decades ago to help people diversify their investments without needing much money. With many different investors putting money into this fund, they “mutually fund” the account (this is pretty tough, huh?? ;)) that invests in many different companies.

Mutual funds often center themselves around a certain industry such as real estate, entertainment, medical, or technology, and they’re often named quite clearly for their focus (ie. “T. Rowe Price Global Technology Mutual Fund” invests in….global technology).

Index Funds – These funds are similar to mutual funds, but instead of the account purchasing many different company shares of a particular sector, it’s modeled after a particular index. The Dow, the NASDAQ, and the S&P 500 are all indexes. One of the top index funds is the Vangaurd 500 index fund. Put your money here, and your earnings will look incredibly similar to the S&P 500 index that you see in the newspapers every single day.

If you’re not looking to beat the market (and you probably shouldn’t be, since very few people ever do), then the Index Fund option is probably the best place to park your money. Invest consistently over a long period of time, and you’ll likely win with your investments. Simple, clean, easy. Just how investing should be.

5) Compound growth

Almost everyone has heard of compound growth, but very few really take it to heart. If they did, nearly everyone would be a millionaire because it’s really just that simple!

Let’s say that you work your butt off for the next five years and save up $100,000. Not easy, but possible.

Next, invest it and don’t add another dime. How much would this $100,000 grow into?

Basics of Investing 1

At an average of 11% interest, the first year grows to $111,000. Pretty cool, but also a bit underwhelming.

In Year 2, your $100k becomes $123k. Again, pretty cool, but not earth shattering.

At this rate, your 11% compound growth doesn’t seem to be doing much of anything.

Basics of Investing 2

Thankfully, you hang in there and leave your investments alone. By year seven, your $100,000 has actually doubled!

Compound Interest – What You NEED to understand

So that was pretty cool, right? Your $100k became $200k. But just like Bachman Turner Overdrive sang back in 1974, “You ain’t seen nothin’ yet!”

It took 7 years for that $100k to double into $200k. So how long before it turns into $300k? Another seven years?

Ummm….nope.

In another 7 years, your $200k will become $400k.

Then in the next 7 years it’ll double again, to $800k.

And then $1.6M in just 7 more years. And $3.2M seven years after that!

Isn’t this just crazy? Nope. It’s just compound interest – the fifth lesson in the basics of investing.

Basics of Investing 3

Now, of course the market doesn’t grow by exactly 11% every single year. Sometimes it’s more, sometimes it’s less, but what if this were the average? $7M here we come!

Compound interest – it could literally change your life.

My Investment Firm of Choice? Motif Investing

I began trading with Motif Investing a little over six months ago. I liked their structure then and I love it even more today. Heck, I enjoy their trading platform so much that I decided to partner with them and become an affiliate! It’s amazingly easy to recommend a company that you truly believe in.

Check it out:

  • You can create a portfolio of 30 stocks and pay just one transaction fee (this is unheard of by the way)
  • Stocks aren’t constantly moving in and out of your portfolio, so you never pay management fees
  • Make 5 trades and they’ll actually pay you $150. Now THAT’s pretty awesome!
  • It’s a fantastic way to invest outside of your 401(k)

Want to sign up? Follow this tutorial (I made it myself, so you know it’s good! ;)) or click the banner below.

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5 comments to The 5 Basics of Investing That Everyone Should Know

  • Funny stuff, I laughed at your comment of 23% of 1,000 is pennies compared to 8% on 100,000.

    A few years ago, I was messing around with a brokerage account with about $750. I was mainly buying stocks which were valued at less than $5. I won some and lost some. When I realized I wasn’t going to go from $750 to $7,500, I stopped wasting my time and focused on building my income and investing smarter.

    (2) is a great point. The underlying asset is not a share, it’s the actual company. This is something I want to apply in my investment life: even if the share price is down 10% or 15%, the company value will not be down as much. The economy just doesn’t move that fast.
    Erik recently posted..How to Think About Money

    • I was the same way Erik. I was investing $250 when I was 23 years old. I earned $80 on it (yay), and then I paid more than that to process the earnings during tax time (not yay)! I probably should have just paid off the debt I had at the time instead…

  • If I can my thoughts to number 5? The rule of 72 offers an estimate for the time it takes to double. At X%, it will be approximately 72/X years. I’m retired, and now spend 2 days a week in a high school math help center. I use this fact to help students recognize reasonable solutions for exponential growth problems, but more important to teach them your lesson 5.

    Students have nearly 50 years until they’d be at “normal retirement age,” At the rate of doubling every 7 years, they would see 7 doubles. Not 7 times their money, 7 doubles. 128 times their money. If a smart one asks about inflation, I say let’s adjust, and from a 10%/yr return, drop to 7%. Now it takes about 10 years to double, and in 50 years we get 5 double, that’s still a 32 fold return. These kids are starting to earn some decent money, and I encourage them to use a Roth, getting tax free growth. I tell them to think of this as a time machine (Sorry Derek, I’m a big SF fan!) and the Roth is a way to send your future self $32,000 in real money for every $1000 you can spare today.
    JoeTaxpayer recently posted..How I Changed to an S-Corp to Lower My Taxes

    • Exactamundo. The Rule of 72 is a great way to understand how quickly your money will double. And then double again. And again! Ahhh, I just love compound interest, don’t you? 🙂

  • […] If you have no interest in using the lump sum of money now and don’t want to manage any additional responsibilities over the next few years, then it’s probably best to invest the cash in an IRA. To do this, simply contact a brokerage company (or your local bank), load up an IRA with your funds, and then invest them according to your investment preference (don’t know anything about investing? This article might help: The 5 Basics of Investing That Everyone Should Know). […]

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