A no-nonsense take on how stocks work, buying bonds, and the best way to invest in stocks and bonds for a rich life.
Investing is the single most crucial thing you can do to ensure your financial future — and the sooner you start, the easier it is to get rich.
Straight up!! There’s more than 100 years of evidence in the stock market that suggests this.
And yet, people still don’t understand what investing is exactly. Folks seem to think there is some magical way to make a fortune with stocks and bonds. From what I’ve seen, the two things people get most wrong about investing are thinking:
It’s a 24-hour Wolf-of-Wall-Street-style party where traders make millions of dollars daily while screaming “SELL! SELL!!” into a phone.
Investments are incredibly risky because all the pundits scream “financial crisis!” at even the slightest dips in the markets.
And, frankly, you have every reason to believe this.
Thanks to Hollywood and the (annoying) talking heads on cable news, we’ve come to think of investment as a maniacal creature that’s not suited for the average person…
…and many of us just don’t understand exactly how investing works.
That’s why I want to dispel some of those myths and notions surrounding investing by focusing on some of the most common topics you’ll hear when it comes to investments:
How do stocks work?
When you own a company’s stock, you own part of that company. Stocks are also called equity for that reason — you own a tiny piece of the company.
• Stock basics
• Choosing the right stock
• Stock research resources
Stock Basics
If the company does well, your stock will do well. You can buy and sell whenever you want through your broker or self-serve sites like E*Trade or TD Ameritrade.
Inevitably, whenever I’m teaching someone about the basics of stocks, someone will pipe up with a myriad questions like these:
“What stocks should I buy?”
“Is X company a good investment?”
“Is $XX too much for this stock?”
First thing’s first: SLOW DOWN.
Before you make an investment in any sort of stock, you’re going to want to stop and make sure you understand how to go about making a decision of what stock to buy.
Choosing the Right Stock
The simplest way to narrow down the universe of stock options is to think of companies you like and use.
Take some time right now to write down 15 companies you use and return to time after time.
Think of everything. For example:
Food: Whole Foods, Conagra, Shake Shack
Clothing: Under Armour, Limited Brands, Etsy
Services: IBM, UPS
Technology: Apple, Microsoft, Snap
Entertainment: Disney, Live Nation, Netflix
Transportation: Tesla, Ford, CSX Corporation
Instead of 5,000 stock options to choose from, you now have 15 companies you could possibly invest in.
Remember: A good company isn’t necessarily a good stock!
For any stock, you’re going to need a deeper analysis than “I think khakis from Gap are awesome, so I’ll buy stock from them!”
Instead, you’re going to want to look at 5 different areas:
Trends: Are sales increasing from this time last year? 2 years ago? 5 years ago?
Products: Is the future bright in terms of upcoming product development? What news have you heard about their future products?
Revenues/profits/growth/earnings per share: The real financial nuts and bolts of a stock. These are intimidating at first. Luckily, many sites will guide you through it.
Insider trading: Are senior executives at the company buying more stocks (indicating they have confidence in the company) or selling?
Management: Is management good? What is the turnover? What is their philosophy and ability to execute?
You can get all of this information online for free — and you’d be wise to do as much research as you possibly can. If you see a reason to doubt a company based on any of the areas above, avoid that stock.
Stock Research Resources
Here are some great websites to help you start out:
Investopedia: The be-all-end-all investment resource for beginners
Yahoo Finance: Lets you view the standard details about any stock
The Motley Fool: Great for first-time investors
At first all of the charts, earnings, and balance sheets will be incredibly confusing — but the more you look into them the more you’ll start to get a good sense of what’s going on. It just takes practice
Advantages of stocks You can really make some money if your stock is good. If your stock is excellent, you can really beat the market. You can pick the stock in an industry you understand. Also, your money is liquid, which means you can access it at any time by selling your stock.
Disadvantages of stocks Unfortunately, if a company does poorly, so does your stock. Because a stock isn’t diversified, that can mean disaster for you (although you can easily reduce your risk by picking bigger, solid companies).
Also, most people think that investing is “picking stocks” but most wealthy people don’t do that — and I’ll show you what they DO do later in this article.
What are bonds?
Bonds are like IOUs that you get from banks. You are lending them money in exchange for a fixed amount of interest.
• Bond basics
• Advantages of bonds
• Disadvantages of bonds
Bond Basics
If you buy a 1-year bond, the bank says, “Hey, if you lend me $100, we’ll give you $102 back in a year.”
The approximate current rate of return for a 2-year bond is about 2%.
Overall, bonds are:
Extremely stable
Guaranteed to have a return
Smaller in their returns
With these qualities, what kind of person would invest in bonds?
Well, anyone who wants to know exactly how much they’re getting next month should invest in bonds. It doesn’t matter if you’re in your twenties or if you’re in your seventies. If you want a stable investment — despite the lower returns — then bonds are for you.
After all, some people just don’t want the kind of volatility the stock market offers. And that’s fine.
Advantages of Bonds
You know exactly how much you’ll get when you invest in a bond.
You can choose the amount you want a bond for (1 year, 2 years, 5 years, etc).
Longer time periods can yield you higher return rates.
Bonds are extremely stable, especially government bonds. The only way you’d lose money on a government bond is if the government defaulted on its loans — and it doesn’t do that. It just prints more money.
Disadvantages of Bonds
Because they’re so stable, the reward on an excellent bond is dramatically less than an excellent stock.
Investing in a bond also renders your money illiquid, meaning it’s locked away and inaccessible for a period of time unless you’re willing to incur a big penalty to take it out early.
Unlike stocks, bonds are hard to buy and sell as an individual.
A No-Nonsense Look at Investing in Your Future
When it comes to what you want to invest in, I think both stocks and bonds are solid investments — as long as you do your research.
When it comes to what I think EVERYBODY should be doing when it comes to their investments, it’s simple: low-cost, diversified index funds.
Let’s look at a real world example.
Say you’re 25 years old and you decide to invest $500/month in a low-cost, diversified index fund. If you do that until you’re 60, how much money do you think you’d have?
Take a look:
$1,116,612.89.
That’s right. You’d be a millionaire after only investing a few thousand dollars per year.
Smart investments are about consistency more than chasing hot stocks or anything else:
The two essential ways to invest your money are straightforward:
401k: Take advantage of your employer’s 401k plan by putting at least enough money to collect the employer match into it. This basically means that for every dollar you contribute, your company will match that (pre-tax!).
This ensures you’re taking full advantage of what is essentially free money from your employer. That match is POWERFUL and can double your money over the course of your working life:
Roth IRA: Like your 401k, you’re going to want to max it out as much as possible. The amount you are allowed to contribute goes up occasionally. Currently you can contribute up to $5,500 each year.
For financial security, it’s more important than anything else to start early. And don’t worry if you think you’re a little late to the game. After all, the best time to plant a tree was 20 years ago…the second best time is NOW.