Welcome to the first part in Investing For Two's beginner's guide to investing! It's always an exciting journey to learn something new, and investing is something you definitely want to pick up earlier rather than later in your life.
This guide will walk you through the basics of investing, all the way until you're ready to make your first (and hopefully not last) investment. Along the way, you'll learn:
- What is investing and why you need to be investing
- Understanding the risks of investing and your risk profile
- The basic asset types, bonds, stocks and real estate
- The prerequisites before starting to invest
- Understanding growth, value and returns
- Investment strategies and dollar cost averaging
- Researching, making your first purchase and more!
Already know all these? Check out our intermediate guide to investing on how to analyze stocks and how to allocate your portfolio between various investment products based on your financial goals!
In this first part, I'll attempt to give an introduction on why our lives are intricately linked to money, what investing is and why it is important.
The scarcity of time
It's necessary to understand the concept of money and time before beginning to invest. Without such an appreciation, one may not truly understand why we need to be investing, or what the goal of investing is.
Here's the postulate - money is synonymous with time, the most precious thing a human could own. We invest our money to buy us time.
Time flows ever forwards and never back (at least, for now). As humans, we have an unlimited potential to learn and grow, but we do not have unlimited time. In our short, harried life, we are always looking for ways to extend our time in this world, whether for pleasure, for purpose, or for obligation.
To put it in perspective, here's my recreated life calendar inspired by this post from Wait But Why. Each box is a week in your life, and each row is a year. If you're 35 years old, the black boxes represent the life you've lived so far, and the blank boxes represent how much time you've left, assuming you live to an average age of 80. Take a look.
Sure, it seems like a lot of weeks to live. And it is. But what happens if we look at it from the perspective of time? When you were born, you had to go to school. After school, you had to work to make money. Assuming we will work all the way until age 65, we would have spent more than three quarters of our life not doing what we really want to do.
Look at the calendar again. Anything above the red line of retirement is time you spend laboring for money. After retiring, the amount of blank boxes you've left to live... is not quite as much any longer. That is the time that you truly have to yourself, without responsibilities or worry.
We are spending the better part of our lives working for money. And in the end, when we do have the money and the free time, we might not have the energy and will left to enjoy that time.
Are you happy with where you're at right now? Are you doing the things you want to be doing with our limited time in this world? These are important questions that we must ask ourselves.
If you are, great! Chances are, you've already taken control of your life and you know what you should be doing and are doing it. But if not, then you'd better start making every last one of those blank boxes count.
The rat race
If you're still alive today, you probably have some sort of reason to carry on living. Something that makes you wake up in the morning each day and go: "Damn, I need to pee."
Maybe it's love. Maybe it's an obsession, like a childhood dream you haven't fulfilled. Maybe it's obligation. In any case, you probably have something that keeps you alive, or at least, the hope of discovering something to keep you alive.
No? Just depression? Well... ahem. Maybe our how to be happy guide can help you with that.
Either way, a reason to live or not, society shackles us the same. We want to have free time to discover and/or do the things we really want to do. But to trade for our "free time", we have to first give up our "free time" by working or studying to make money. Sounds stupid when you think about it like that, doesn't it?
You, I, and most people around you are in this huge hamster wheel that keeps spinning round and round. Giving out our time for money. Using that money to buy more time. Using that time for momentary happiness. Rinse and repeat. We call this "the rat race".
Ignore the deceptively cute rat. You can run and run, but you'll never get out. Or can you?
The money-time optimization problem
In the end, what all of us are trying to do is to live out our dreams and find something we really like to do. The roadblock between us and that goal is money.
Money is necessary. That is irrevocable in today's society. It can buy you survival necessities like food, shelter and utilities. If we have so much money that we no longer have to worry about the bills, we wouldn't have to work unless we enjoy it.
Having money frees up time for you to learn the skills needed to chase your dream. It frees up the time for you to travel, explore and grow as a person. In fact, having money frees you up to do anything you want to do.
But we have to put in our time to make money. That is an immutable fact unless you were born with a golden spoon. Money is the limiting factor to the amount of time we have to ourselves. The question is then simple. How can we minimize the time we put in to make money, and maximize the time we have for our own dreams?
The solution, as always, is as simple as it sounds. Minimize the time you spend to make money, and maximize the money you earn. Accumulate enough money, and you're effectively free to chase your dreams or do anything you want to do.
Is that even possible? If you're here, you probably have some idea of what we're going to do. Yep. Investing is a way out of the rat race.
The concept of investing
Let us get a basic look at how our economy works. If we assume that the world's resources are infinite (which they are, if we get to space), then by definition our economy can grow infinitely.
This is important because if our economy was closed and circular, then someone's gain must be somebody else's loss. The rich would never let the poor become richer, because that would mean that they were becoming poorer.
Luckily, this is not the case. Since our economy could grow infinitely, it meant that everyone could stand to gain and grow richer at the same time. It also meant that everyone could partake in the surplus of our economy instead of just a select few.
If the poor get richer, they can spend more to buy more things. As a consequence, the rich will get richer too (they can sell more things). Win win for everybody.
Built upon this basis, the concept of investing was born - allow the masses to participate in the funding of companies. Thousands of small streams can make a raging river. The pooled together money would reach large sums, allowing the company to further expand their business. The company would then redistribute their profits to the masses, and the cycle repeats.
Now, instead of the rat race, we have this.
This is the basic concept of investing. The investor (you) pays money to hold a small stake in a company, and the company uses that money to grow their value, which in turn, increases the value of the stake you now hold.
There's a key takeaway here. As the investor, all you have to do is to put in your money into a company. They'll do all the work, and then (hopefully) your money grows in value. Of course, that is simplifying things a little bit, but you get the idea.
What has changed? Well, for starters, you are not the one doing the work anymore. In essence, your money is working for you. Whether you are sleeping, eating, or pooping during work, the company you invested in is growing your money's value for you. And that is essential.
Instead of one stream of income, you now have two. You can still go to work and get a salary. But now, even your money is working for you without your intervention. Now you have two streams of income. Remember that saying about how multiple streams make a raging river? Now imagine if instead of investing just once, you invested many times. Perhaps the same company, perhaps different companies. But each one of them is trying to grow your money for you. Each one of them is a new stream of income.
Accumulate enough streams and gradually, the income that your money brings in by working for you is enough to take care of your expenses. Suddenly, you don't need a job and that salary to support your obligations any longer. Suddenly, the time you have in being alive belongs to you fully. You are free from the rat race.
The monster that is inflation
Sounds good? It is good. But not so fast. We have to go deeper to understand why we truly need investing. There's this nasty thing called inflation. Remember when we said that the economy was growing infinitely? Well, it turns out that if everyone is getting richer, then things are just not worth the same anymore.
What does this mean? Imagine if everyone had more money. What would they do? Why, they would buy stuff, of course. That is the entire basis of how our economy works.
With more people buying things, the demand for goods and services increases. Due to the increased demand, prices go up. Simply put, if more people want something, then that thing has more value and should thus be charged more.
On a basic level, this is how inflation happens. When all the prices go up, your money loses value because for the same amount of money, you can now buy less things. Inflation is the average increase in prices of goods and services.
Great, now that we know what inflation is, what is the inflation rate? As everyone gets richer, inflation is also growing as a side effect. In fact, the annual inflation rate for goods and services ranges from around 0.5-3%, depending on which country you're from. This means that on average, goods and service increase their costs by 0.5-3% annually, and as a direct consequence, your money loses value at the same rate every year.
This also means that if you leave your money in a bank and forget about it (not counting interest rates), your money would be losing value every year at a rate of 0.5-3%! That's not good at all. Inflation is a monster.
Creating income streams
So we know that inflation is bad. We need to beat inflation rates, or we would be losing money every year! Let's see what happens if you only have a single income stream (i.e. your salary).
At time of writing, global real-wage growth is expected to be around 3-4%. This means that salaries are growing more than the average inflation rate of 2.8%. That's good, and it's to be expected! If salaries didn't grow faster than inflation, the overall spending power of the population would drop as people cannot afford goods and services, causing our economy to crash.
But take a look at the difference in growth rates. If salaries grow at an average of 4% globally, and inflation rate occurs at an average of 2.8%, our money's barely growing in value at a measly 1.2% difference. Sure, you can afford your expenses now when you have a salary, but what happens if...
- You lose your job
- You have an illness/accident and need to be hospitalized
- You have unpaid debt or mortgage
Without your salary coming in, your 1.2% growth in monetary value is not going to cover your expenses at all. This is why we need to be investing. We need separate streams of income that both support us and do not require us to work for it. We need a healthier growth rate for our money to cover for unintended expenses and more.
By creating multiple income streams through investing, we give ourselves a way out no matter what troubles come your way. Your goal is to never be financially worried ever again.
Time value of money
Great! Hopefully by now, you have realized the importance of investing both for your life security and to gain more time to do the things you want to do in life.
Remember when I said that if you relied on your salary alone, you would only achieve a measly ~1% growth rate on your money, and that it's not enough to cover your expenses at all? Does investing offer something more? Will it grow your money enough so that you can be financially free even without a salary?
Honestly, those are redundant questions, aren't they? Let's say you invested in a fund tracking the S&P 500, which is a collection of 500 of the largest companies in the US stock market. This means that by putting your money into this asset, you are effectively funding 500 of the world's largest companies, who will then channel their growth back to you.
Imagine if you put $10,000 in 5 years ago. How would you have done?
In 2015, the S&P 500 was trading at around $2,000 per share. Your $10,000 would have bought you 5 shares. 5 years later, in 2020, the S&P 500 managed to grow to almost $3,400 a share. If you sold those 5 shares you own, you would have received $17,000.
In the span of just 5 years, your money grew for you from $10,000 to $17,000. That's a 70% growth in value! Compare that to the measly 3-4% annual growth in salaries and you'll realize why investing is necessary for financial security.
Of course, it's unrealistic to expect this amount of growth for every single investment you make, but the point still stands. By investing, you are putting your money to work for you with the power of the entire global economy. Will your salary grow faster, or will the economy grow faster? Hint: It's not your salary.
Remember, our economy is continuously growing. As humanity becomes more technologically advanced and we unlock more resources, the economy grows larger and larger. As peoples' salaries increase, their increased spending power goes back into the economy, causing compounding growth.
Thus, now that we realize how much growth investing can bring for you as opposed to not investing, we can further examine the connections between time and money. We've all heard the saying: Time is money, and money is time.
Indeed, time is the greatest factor when it comes to growth. If we have a firm belief that the economy as a whole will continuously grow, then over time, any money we invest into the economy will grow over time as well. Since the economy is growing at a faster rate than inflation, the more money we put into the economy, the more growth we are going to get over a long period of time.
This is known as the time value of money. Of course, for now, it is simply explained, but we'll get into it in greater depth later.
Our end goal
Whew. We've come a long way, haven't we? Now that we know about investing, income streams and growth, I would like to bring you all the way back to the beginning. What is our end goal in all of this?
Let me recount to you an interesting story I read. It is known as the Parable of the Mexican Fisherman, and relates heavily to what we've discussed today. The following is a condensed version of the story.
An investment banker was on holiday at a small seaside town when he spotted a fisherman coming in with his catch for the day. Interested, he went over to take a look.
"Those are some large fresh fish you have there," the investment banker said. "How long did it take for you to catch them?"
" Only a little bit," replied the fisherman.
"Why not stay out there to catch more fish?" The banker asked.
"It's enough for my family's needs," the fisherman answered as he docked the boat.
The banker then asked, "But what do you do with the rest of your time?"
"Well," pondered the fisherman, "I sleep late, fish a little, play with my kids, take siesta with my wife, and stroll to the village in the evenings where I sip wine and play my guitar with my amigos. I have a full and busy life."
"A full life?" The investment banker scoffed. "You could spend more time fishing, and use the surplus in proceeds to buy a bigger boat. With that, you could catch more fish, and then buy another boat. Eventually, you would have a whole fleet of fishing boats. Thereafter, you could buy a factory and control the processing and distribution of the entire fishing chain. You would be rich!
"Of course, you'd have to leave this fishing village and move to the city to run the business," the banker added.
"But, how long will this take?" The fisherman asked curiously.
"15-20 years, give or take."
"But what happens after?" The fisherman questioned.
The investment banker laughed and said, "That's the best part. Having grown the company, you could IPO and start selling your company stock to the masses. Then you would be very rich, and become a millionaire."
"A millionaire?" The fisherman scratched his head in thought. "Then what?"
To which the investment banker replied, “Then you would retire. You could move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your amigos."
I find this short story very interesting as it examines an aspect that many people in their hectic lives tend to forget. Let us be clear about this ourselves before we start our journey into investing.
Money is only a means to an end.
Sure, having money is great. No one denies that. It affords you so much convenience and freedom in your life if you have a lot of money. But money can't buy happiness. Not the meaningful ones.
Money can't bring a loved one back to life. Money can't help you fulfill your dreams if you yourself don't work hard to make it a reality. Money can't help you be truly happy.
So invest. Try to get rich. Be financially free. But remember your end goal, which has and always been to do what you really want to do in life.
Remember, time is your greatest and most scarce resource. Once it's gone, you're never going to get it back. Don't be too preoccupied with money that you forgo the things that truly matter. Spend time with your loved ones. Spend time doing the things you've always loved to do.
Learn to spend time on yourself, too.
If you have digested all that, then great! I hope you enjoyed it, and even learnt something from it. When you're ready, move on to part 2 of our beginner's guide to investing on risks and asset types to continue your investing journey!
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