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I don’t know about you, but when I ventured out on my own trying to learn about investing and how the stock market works, I was super intimidated. After all, only 23% of millennials prefer investing in the stock market to cash.
When I saw stats like that, it only reconfirmed my belief it was just about impossible to figure this stuff out. My parents used to work on Wall Street when they were my age and sometimes I’d ask what they did and they’d begin talking about futures, swaps, the bond market, par, etc., etc. and I’d be like how the hell do you even understand anything it’s a completely foreign language!
It seems like a scam right? All these ridiculous terms that even some traders don’t fully comprehend.
Just read Michael Lewis’ hilarious book Liar’s Poker to see for yourself how much these guys ripped people off.
But the reality is, you don’t need to know any of that garbage. It’s all fluff specifically intended to confuse people like you and me to take advantage of us.
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Here are the top 10 ideas you should be familiar with:
Simple interest is when interest or a fee is charged to a set principal amount of money typically in the form of a loan. You usually see this in the form of car loans or short-term loans. In this scenario, payment is first made on the interest and then it’s applied to the principal if there is leftover money to help pay off the loan.
So say you borrowed $10,000 at 4% for 5 years. Interest = Principal x Rate x Time: $10,000(3%)(3 years) = 900. You will have accrued an interest in the loan for a total of $900.
Simple interest is different from compound interest in that it is simply interest off the original principal amount.
It is not interest on top of interest; if that were the case, the amount would end up being $10,927.27 (1 year: $10,000×3%=$10,300, 2 years: $10,300×3%= $10,609, 3 years: $10,609×3%=$10,927.27). That is called compound interest.
Compound interest is a little different. This is where the magic happens.
It’s the secret ingredient that’ll help you retire years earlier than your friends if you’re willing to stay dedicated. Compound interest is when interest is accrued on top of the previous interest that was already gained on the principle and so on and so forth.
So for example, if you have $100, if it was a simple interest loan at 10% for 5 years, you would owe $150 after 5 years ($100×10%x5 years).
If it was compound interest, it would be $161.05:
year 1: $110 ($100 x 10%)
year 2: $121 ($110 x 10%)
year 3: $133.10 ($121 x 10%)
year 4: $146.41 ($131.10 x 10%)
year 5: $161.05 ($146.41 x 10%)
When you use small amounts like that though, it doesn’t do it justice for how much of a positive effect compound interest can have on your net worth. Say you make $65,000 and never had a pay raise the rest of your 40-year career. Your employer matches 50% of your 401k contributions up to 6%, so it’s just a confusing way of saying it’ll match up to 3% of your salary in 401k savings if you max out the contribution limit.
That 9% of $65,000 is $5,850. It doesn’t seem like much, but after doing this for 40 years with an average rate of 7% performance, that turns into $1,249,615 without reinvesting dividends.
If this was including the average 4.41% dividend yield of the S&P 500, then you’d end up with $4,251,630 if you invested it all in a Roth 401k in an S&P 500 index fund. How insane is that? Compound interest is the best.
This is a subject people typically get confused about. A lot of people believe a stock is a piece of paper that has a dollar amount on it that you can trade in for cash and that’s it. Well, for one thing, the days of paper stock are well over. These days everything is done electronically over the internet.
But another thing is, it’s not just a piece of paper or a certificate with money attached to it; it’s a piece of ownership in the company you bought stock of. This is why you are able to participate in the shareholders’ meeting and are able to vote on issues brought up within the company during those meetings. That’s a tremendous advantage you have over others who aren’t invested in the company!
Sure it might not be a lot of stock compared to how much stock a particular company bought in the company you have stock in, but it is still something and it still counts.
When more people buy stock of a company, that stock price rises. When more people sell the stock of a company, that stock price drops.
What people always get wrong is, they buy stock when everyone else is because the company’s stock is doing well; this seems like a safe bet, but in reality, that person who bought stock in a company after it went up 20% in the first 8 months of the year, probably missed the boat on most of the returns.
Bonds are the opposite of stocks. Stocks are ownership. Bonds are loans. When you take out a bond from a company, you become the lender to the company. Say you buy a $1,000 bond. You are giving or lending the company $1,000.
Typically, you hear bonds are at X amount with a Y% yield over a certain amount of years until the “maturity date” or until the bond is due to end and you receive your money in full value. These days, everyone is obsessed with what the Federal Reserve is doing with raising rates. When you hear people say the Fed raised rates to 3.25%, they mean the interest rate on which banks lend reserve balances to other banks on an overnight basis.
On average, bonds have returned between 5%-6% compared to 10% for stocks. People love bonds because it is more or less a guarantee you will receive your investment at that set interest rate if you hold onto the bond until the maturity date. The safest bonds are U.S. Treasuries; unless the world ends, basically it is guaranteed you will have your investment at the set rate you bought treasury bonds at in 10, 15, 30 years, whatever type of bond you bought.
You are lending money to the government in this case in which they are borrowing it and guaranteeing you a payment for a later date at a set interest rate. People love bonds because they mistakenly view them as safe. But they become eroded by inflation especially when compared to stocks.
Unless bond rates go up to 15% as they did in 1982, there’s no reason to consider them. Just do the math, it doesn’t make sense to invest in bonds that perform literally less than half as well as the average of the stock market with inflation considered (7%).
The Stock Market:
The stock market is where people go to buy and sell stocks. It’s a combination of all the public stock exchanges in existence. There are stock markets all over the world, but the most famous is the United States stock market. The hours of the United States stock market are 9:30am-4pm Monday-Friday.
You can buy and sell stock before and after those hours, but the trades will not be processed until the next opening, which is typically the next day unless it is a bank holiday or of course, the weekend. My favorite app that I use to buy stock on the rare occasions that I do, is the Charles Schwab app.
The New York Stock Exchange:
This is the world’s largest stock exchange by market capitalization, which means the total amount of money within the stocks of the companies that are a part of the exchange. It’s located in the Financial District of New York City.
If you haven’t been, it’s a pretty cool site to check out. I think you can still get tours there, I went on one once and thought it was interesting to see where everything goes on. It looked completely different compared to the pictures I saw with papers flying around, there was hardly anything since everything is electronic now.
The NASDAQ stands for National Association of Securities Dealers Automated Quotations. It’s the second largest exchange behind the New York Stock Exchange. It was actually the world’s first electronic stock market, which I think is pretty cool.
The NASDAQ is comprised mostly of tech, biotech, media and communications companies.
The New York Stock Exchange, on the other hand, varies from high growth companies to blue chip companies which are older, widely accepted, more stabilized companies. The name blue chip comes from poker where the blue-chip has the highest value.
Mutual funds are collective pools of investors’ money to invest in things like stocks, bonds and even other securities like precious metals. These are actively managed, which means a money manager consistently buys and sells in an attempt to beat the market.
And on top of that, almost no managers have beaten the market over the past 15 years. It’s a scam if you ask me. There’s no reason to be charged 1%-2% to get worse than an average performance of a return on your money. It doesn’t make any sense. You wouldn’t take that deal in any other circumstances.
This is the worst place to be taking that deal. Play it safe and invest in an S&P 500 index fund.
Index funds are similar to mutual funds, except they are not actively managed. Index funds track a specific index, and do no better nor worse except for maybe a few hundredths of a percent in fees. It’s a lose sum game, but hey, this is the best way to minimize it.
One of the most popular index funds is the S&P 500 index fund, which I highly recommend
This index fund holds a tiny piece of each of the 500 companies within the index. When everyone says the market did this, the market did that, the average performance of the market is X, they mean the S&P 500.
If you don’t want to learn any more than is required to play it safe and go on with enjoying your life, invest in an S&P 500 index fund the rest of your life and you can’t go wrong.
And don’t worry if people or your 401k robo advisor says it’s risky to put all your money in one index fund.
If you had invested in each stock individually yourself, nobody would say that’s risky, in fact, they would probably say you’re too diversified! Just because it’s bundled into one index fund, it gives the illusion it’s one investment. But it’s not, it’s 500 investments wrapped in one.
Who could ask for more! With an average 7% performance, that’s a great deal, especially considering that’s better than the performance of 99% of mutual funds and money managers.
401k, IRA, Roth 401k & Roth IRA:
These are the primary accounts to help you with your retirement savings. Initially, these were considered just saving plans to compliment your pension.
Today, hardly anyone has a pension plan. In fact, the company I work for scrapped their pension plan after my 8 months of employment, so I couldn’t even get a minimum one-year vested amount. Whatever, it’s all good.
The 401k is your retirement savings plan given to you by your employer. Most companies offer one and some even offer a matching plan. What this means is they will give you free money.
Literally, I’m not kidding.
So for me, my company matches 50% of my contribution up to 6% plus an automatic 4% regardless if I participate in the 401k plan myself with my own salary or not.
So the minimum I am putting into my 401k plan if I meet the matching plan, is 13% (6+3+4). You always want to do the matching amount if your company offers it because if not, you are throwing away money the company is willing to give you for no extra work. It’s a pretty good deal!
There are typically two types of 401k plans offered, a regular 401k or a Roth 401k. The difference is, the Roth 401k is taxed upfront and is not once you start making withdrawals. This is great, because if you expect to be in a higher tax bracket later on in your career, you avoid being taxed a higher rate.
When you withdraw the money from your Roth 401k, it comes out without being taxed, because you already paid the tax when you were young. As of the date this post is being drafted, the maximum limit to contribute to a 401k or Roth 401k is $18,500. I maxed mine out when I was living at home and it made a world of a difference for me.
Do it if you can!
The same idea is applicable for your Roth IRA and IRA. It’s the same rules. It stands for Individual Retirement Account. The maximum you can contribute is $5,500. I personally think this is a load of nonsense. I’m not one for conspiracy theories but I think the only reason why it’s so low is so people keep spending to keep the economy going. And you can only contribute to a Roth IRA if you meet these requirements.
There’s literally no reason in my mind that it can’t be higher. So to combat this, I use my Schwab One account to supplement this. This is my brokerage account. I do have cash in a money market fund for short-term purchases, just because you never know when the stock market is going to go down, so I don’t want to be a victim of that in the short-term. But my other savings are strictly for retirement purposes only.
If you get started with these basics, that’s more than enough to prepare yourself to get ready to start reading books on investing if you want to learn more. You can get started here.
If you have any questions, shoot me a comment or an email I’d love to hear your thoughts!
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