Stock Investment |
While we certainly appreciate the plug, somehow we don't think that Mr.
Baruch had our kind of Fool in mind. We feel that the main purpose of the
stock market is to help enrich those who methodically save and invest,
employing a buy-and-hold philosophy. Be a Fool! Buy 'n' hold! The others, the fools, may well be made idiotic by trying to predict
the daily swings of the market.
Why invest? Say you take $2000 of your savings and put it into the stock market. If
your money returned 11% a year (the S&P 500's historical average), two
grand would be worth $53,416.19 after 30 years. You could buy that Tuscan
retirement villa (or at least come up with the down payment) with that
kind of money.
Maybe you don't have $2000 burning a hole in your bank account, but
perhaps you can afford to invest your lunch money. Brown-bag your lunch
and sock away just $4 a day, 250 days a year. It's not a lot, but if
you're in your early 20s, you've got the investor's best ally on your side
-- time. If you invest $1,000 once a year in an investment that averages
an 11% annual return -- the annual stock market return since 1926 -- it'll
grow to more than $1 million after 46 years, which is right around the
time you'll be ready to retire.
Of course, as you get older and more financially stable, you should be
able to put away more to invest. Upping the ante to just $166 a month
(lunch money plus about what you pay for basic cable TV and a movie
channel), would put you at the million-dollar mark in just 39 years.
Simply put, you want to invest in order to create wealth. It's
relatively painless, and the rewards are plentiful. By investing in the
stock market, you'll have a lot more money for things like retirement,
education, recreation -- or you could pass on your riches to the next
generation so that you become your family's Most Cherished Ancestor.
Whether you're starting from scratch or have a few thousand dollars saved,
Investing Basics will help get you going on the road to financial (and
Foolish!) well-being.
The power of compounding Growing At
Why is the difference between a few percentage points of return so
massive after long periods of time? You are witnessing the miracle of
compounding. When your investment gains (returns) begin to earn money,
too, and those returns start to earn... small amounts of money can
mushroom very quickly. Extend the time period or raise the rate of return,
and your results increase exponentially. For instance, if you start young,
say at 15 years of age, note how quickly a single $100 investment grows,
especially in the later years.
Growing At
Looking at it another way, let's compare two teenagers and their
lifetime savings habits. Bianca baby-sits a lot and spends most of her
spare time reading. She saves $1000 a year starting when she's 15 and
invests it in the stock market for 10 years earning 12% per year on
average. After 10 years, she comes out of her shell, stops adding money to
her nest egg, and spends every penny she earns club hopping and on trips
to Cancun. But she keeps her next egg in the market.
Compare her account to that of her friend Patrice, who squandered her
early paychecks on youthful indiscretions. At age 40 Patrice gets a
wake-up call when her parents retire on nothing but Social Security. She
starts vigorously socking away $10,000 every year for the next 25 years.
Guess who has more at age 65? That's right, Bianca. (You figured it was a
setup, didn't you?) Her 10 years of saving $1000 per year (just $10,000
total -- the same amount Patrice put away in just one year) netted her
$1.6 million by age 65. Patrice, on the other hand, scrimped for 25 years
to invest a quarter million dollars out of her own pocket and ended up
with just under a million. Neither will be going to the poorhouse, but you
see our point: Bianca's baby-sitting money grew for 50 years, twice as
long as Patrice's, and Bianca barely missed it.
(It's almost not fair to mention this, but Bianca's money was in a Roth
IRA. Patrice could only put 20% of her money in the Roth ($2000 per
year). So Bianca's $1.6 million is tax-free, but Patrice will be paying
capital gains taxes on most of her money.)
We will revisit the subject of compounding in Step
2, but for now suffice it to say that the power of compounding is the
single most important reason for you to start investing right now. Every
day you are invested is a day that your money is working for you, helping
to ensure a financially secure and stable future.
Getting ready to invest Why? Because, by the very same principle discussed above, a dollar of
debt can quickly compound into a few hundred dollars of debt. Does
it make sense to try to save money at the same time your debts are
multiplying like bunnies? The first thing you should do to prepare for
investing is to pay down all of your high-interest debt, such as credit
card debt. Although some kinds of debt may be low-interest or
tax-advantageous (such as your mortgage), the rule of thumb is: Be free of
high-interest debt when you begin to invest.
Every dollar you can put toward investing is a dollar that can work for
you. And, Fool, every dollar you avoid putting in the pocket of a
financial professional, a full-service broker, or a mutual fund manager,
is also a dollar that is creating value for you. (We'll get back to this
point later.)
Pay yourself first We're not suggesting that you obsess over every penny you throw into a
wishing well. (Please don't embarrass your mother by diving in after it.)
If you pay yourself first, you won't have to. What do we mean? When you
pay your bills -- the credit cards, the gas, water, electric, cable, and
phone bills, and the kid who mows your lawn and the one who throws the
newspaper onto your neighbor's porch instead of yours every other morning
-- add one more item to that list. In fact, we think it should be the
first item. Put yourself at the top of that list: Pay yourself first. Then
you don't have to think about it again until next month.
We recommend that you put away as much as possible, with
the goal being to save 10% of your annual income (total, not take-home).
Depending on your obligations, you may be able to save more or less. The
more you save, the more wealth you create -- but anything is better than
nothing. Remember, even a few dollars saved now will be worth more than
lots of dollars saved later. So take advantage of services that
automatically withdraw money from your checking account and transfer it to
some savings
or investing vehicle. You'll be surprised how easy it is to live on a few
less dollars each month. You probably won't even notice the difference.
You can be flexible about this. If you find yourself eating beans and
rice every night for a month (and you don't like beans and rice), then
maybe you're paying yourself too much, or perhaps you're not in a position
to start paying yourself at all. But as soon as it's feasible, jump in.
Remember Patrice and Bianca!
Savings and investment vehicles Short-Term Savings Vehicles
Long-Term Investing Vehicles
"The main purpose of the
stock market is to make fools of as many men as possible." -- Bernard
Baruch
Year
5%
10%
15%
20%
1
$100
$100
$100
$100
5
$128
$161
$201
$249
10
$163
$259
$405
$619
15
$208
$418
$814
$1541
25
$339
$1083
$3292
$9540
Age
5%
10%
15%
20%
15
$100
$100
$100
$100
20
$128
$161
$201
$249
25
$163
$259
$405
$619
30
$208
$418
$814
$1541
40
$339
$1083
$3292
$9540
50
$552
$2810
$13,318
$59,067
60
$899
$7298
$53,877
$365,726
65
$1147
$11,739
$108,366
$910,044
As you'll see later, Fools are
partial to investing in stocks, as opposed to other long-term investing
vehicles, simply because stocks have historically given the highest return
on your money. Here are the most common long-term investing vehicles:
Retirement plans
There are a number
of special plans designed to create retirement
savings, and many of these plans allow you to deposit money directly
from your paycheck before taxes are taken out. Employers occasionally will
match the amount (or a percentage of that amount) you have withheld from
your paycheck up to a certain percentage of your salary. (Pssssst. That's
what we affectionately call "free money.") Some of these plans permit you
to withdraw money early without a penalty in order to buy a home or to pay
for education. If early withdrawals are not permitted, you may be able to
borrow money from the account, or take out low-interest secured loans with
your retirement savings as collateral. Rates of return vary on these plans
depending on what you invest in, since you can invest in stocks, bonds,
mutual funds, CDs, or any combination.
Common Pitfalls to
Avoid
Before you race off through the rest of Investing Basics,
there are some cautionary points to consider before you proceed. These are
common mistakes many people make when considering what to do about
investing.
Summary and Next Steps
Congratulations! You've made it
through Step One of Investing Basics. (Bet you didn't even break a sweat.)
You've witnessed the power of compounding and you understand how debt (and
other common pitfalls) can ruin even the healthiest investing plan.
Empowered with a general sense of the various savings and investing
vehicles, you are now prepared to look at the basic investment concepts.
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