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Investing basics

Investing basics

Now, we’re getting closer to the meaty stuff: growing money through investing.
Contrary to what you might believe, investing isn’t just for rich people, financial advisors, or stock brokers — you can probably do it from your smartphone, right now, in under ten minutes. That said, there are however a few words, phrases, and concepts that will be useful to understand before we dive in.

Investing

Even though it can be a broad topic, for the purposes of this article investing will be defined as “giving money to businesses who work hard to provide goods, sell services, with the aim to grow and make more money”.
Specifically, we’ll focus on investing in large, known companies you can track on the stock market.
Investing is different from speculating, where you buy something (like gold, crypto, or a piece of land) hoping to sell it for more in future. It’s not that there isn’t room for speculating in a good investment portfolio, it’s just that we’ll focus on long-term investing through business growth rather than hoping for price changes.

Some key terms

When people talk about the economy, they mean the sum of all transactions going on around us involving people spending and earning money. Individuals and businesses, generally earn money by providing their services or selling products to other people or businesses.
When investors (which could be hedge funds, pension fund managers, banks, and normal people like you and me) invest their money, they pay money to buy a small piece of ownership in a company, in the form of shares/stocks/equity (all meaning the same thing). Those companies work hard (hopefully) to grow and improve and provide more value, become worth more and more profitable and (hopefully) make some money for you and the other investors.
Some companies share their profits with investors like you who hold shares (the shareholders) by paying a dividend, usually once a quarter. Some businesses may choose to reinvest their profit back into the company to try and become even bigger, more profitable, and more valuable.
If all goes well and the business is more valuable over time, this should be reflected in a higher share price (the price of one share of the company). But, of course, not all companies grow and improve, others go down in value and ultimately go bankrupt. You can buy and sell shares on an investment platform that is connected to one (or many) stock exchanges.

The evolution of (some) businesses

Small businesses are the backbone of most economies. They are also, unfortunately, some of the riskiest investments you can make. Have you ever noticed that real estate black hole; the one shop or restaurant that seems to change owners every few months? These are probably hard-working business owners trying their best, but due to complicated external factors, they can’t remain in business.
Around 50% of small businesses
within five years.
That means, if you invest $10,000 into a small business, all it will take is one bad coin flip to lose your money; 50%. And if you had a “good” coin flip, there is still a limited amount of money that the small business will probably earn and pay you, as a shareholder.
Unless you already have a large and diverse investment portfolio, or if you obsess about your own small business (treating it as a full-time job, working your ass off in getting it first to survive and then to grow), don’t invest in any individual small privately held business for now.
If you personally have met the business owner, you’ve reviewed their business plan, marketing plan, and financial statements in detail, and you’ve done proper due diligence about the risk, you can consider investing 1% of your investment portfolio into such a small business. Again: the data shows you’re very likely to end up losing most or all of your money, but if you lost 1% of your money it wouldn’t be the end of the world.
(Note that in many countries “regular” investors like you and me aren’t allowed to invest in small private companies, due to the high risk of failure and the high probability of losing all your invested money.)
All those warnings aside, some small businesses obviously prosper and grow; Apple was started in a garage.
Some of these growing private companies will decide to become public companies, where they get listed on a stock exchange. After going public (known as an IPO or initial public offering) regular investors can invest in the company by buying shares, which are listed on a stock exchange. They can do this by using a trading app (you don’t have to have a stockbroker anymore), provided by an investment firm.
(If you want to take a deep dive, here are the main.)
Despite being less risky than small private companies, it is still very irresponsible to invest all your money in a single public company.
Many big and trusted companies, vetted by auditors and given the green light by banks and all manner of financial experts have run into financial problems or otherwise gone downhill. Some of them have failed and gone bankrupt, the share price of some going close to zero. Not only can a scandal be brought on by a single CEO, but there are also many external forces that can influence a company’s success.
To be crystal clear: don’t invest in a single public company (or, again, not more than 1% of your investment portfolio).
Why invest in one, when you can invest in many or all of them?

Mutual funds

Mutual funds are investments where investors pool their money together and a fund manager then invests it in a basket of different companies. Some mutual funds focus on the technology sector (buying stocks of only technology companies), others focus on things like agriculture, and others may pick a variety of companies in a variety of industries. It’s up to the fund manager (or fund team) what and when they will buy.
Now, it is certainly less risky to trust a qualified fund manager to put your money in lots of hand-picked companies than for you to try and guess which ones will do well. It’s less risky, but it’s still not the smartest way to invest. This is mostly due to the high fees that mutual funds charge, reducing the profit to the investors (they have to pay for offices and to employ the staff and fund managers to buy and sell those shares on your behalf; this is known as active investing).
That, and the fact that it has been , over and over and over again, that no mutual fund or hedge fund manager has the ability to predict which individual company shares will increase in value faster than the overall stock market.
My goal with investing is simply to invest in the overall stock market. Some mutual fund managers may get higher returns than the overall stock market some years, but most of them don’t.

Index funds / ETFs

So then, on to the magic of index funds.
Index funds (also called ETFs; exchange-traded funds) are similar to mutual funds where investors also pool their money to buy shares in a basket of different companies. The difference is that they automatically invest in a pre-determined list (or index) of companies without the need for expensive fund managers.
This is a form of passive investing; you don’t need to do anything, other than to make the initial (and if you like: ongoing) investments into the index fund, it will do its thing. Set it and forget it.
For example: a bank or financial firm can choose to create a new index, simply called the “World Top Ten”. This will simply be a list of the ten biggest companies in the world (a list that will obviously change as some companies become bigger and smaller and get added or removed from the top ten list as time goes by). So, an index fund that invests in this “World Top Ten Index” will simply own the shares of these ten companies (and sell the ones that drop off and buy the ones that get added over time). Simple as that. No managers needed. No stocks to pick. You simply buy the index.
There are literally thousands of index funds available to choose from today, something which can make the whole process overwhelming for the newbie investor. Some index funds invest only in solar energy companies, others only in oil companies, others may have a regional or industry focus. For now, we’ll focus on the simples ones, the basics, until you’ve added a few more zeroes to your net worth and you’re ready for riskier investments.
I propose starting with the country with some of the most innovative companies, and the largest and most business-friendly market in the world: the United States.
The best-known and most popular index is the S&P500, tracking the listed on the New York Stock Exchange. Over time you can branch out into other ETFs in other regions or industries, but for now, just consider investing in an S&P500 index-tracking fund, one with the lowest fees.
As they say: don’t put all your eggs in one basket. By investing in an S&P500 ETF, you’ll be invested in 500 of the top American companies. These companies earn their profits around the world, not just in the USA. So, you’re invested in 500 different companies, in different industries from healthcare to finance to technology, with operations in different countries all across the world. Many eggs, many baskets.
And don’t worry, you don’t have to be American, be in the US, or need to open an offshore bank or trading account to invest in an S&P500 ETF.
But first...

A little note on risk & returns

There is a correlation between risk and returns. Some bright kid might have good plans to create the next big social media platform. You could invest all of your life savings into her company, hoping to make millions one day, but the risk of the business failing (and you losing all your money) is substantial.
On the other side of the spectrum, you can conservatively put all of your money into a bank account, where it is often guaranteed against financial crises and bank failure (up to a certain amount, depending on your country/government), but by doing so you will never really grow it by much (and inflation will eat away at it).
The US stock market (or rather, the US S&P500) has , on average and measured in dollars, over the past century. This excludes the effects of inflation (which brings it down a bit). It also excludes the foreign exchange losses or, much more likely: foreign exchange gains (for those who live in a non-US dollar country or bought these funds with a currency that has mostly been losing value against the dollar over time).
Investing in the stock market is riskier than keeping your money in a bank or money market account. But there are no risk-free returns. I don’t propose putting 100% of your money there, but it is a place to start.
The economy can turn and many of the companies you’ve invested in can lose value, pushing down the price of their shares and reducing their dividend payouts. Many people panic during an economic downturn and proceed to sell their shares (or possessions or houses) at a loss.
But, as it has shown time and again, . Always. It will take time, but it’s essential to keep a long timeline in mind when you invest in the market. Some years the returns have been close to 30%, other times they were negative by nearly as much. But, over time and on average, the returns average back to 10%.
This also means that you shouldn’t invest money that you know you will need in the short term, but we’ll get to that. As mentioned in a future article: you will need savings that will keep you comfortably alive for three months in a money market or interest-bearing account before you start investing. That said, even if you don’t have three months’ savings right now, you can (and probably should) start with a small amount to buy your first ETF, just to get the process started. Most app-based or online trading platforms require a $100-500 minimum to get started.

Some questions

How much should I invest in the market?
It depends on your risk appetite. Since there is a relationship between time and returns on investment, you should consider putting a higher percentage of your investable money in the market at a younger age, leaving you with more time to ride out the ups and downs (and more time to work and earn money, which you’ll also invest). Every year, as you grow wealthier and get closer to retirement/financial independence, you should consider selling shares and putting more money into inflation-beating accounts and bonds (which can’t go down in value).
Some suggest “keep your age in cash, the rest in the market” (so, if you’re 30, you’ll keep 30% of your money in bonds and cash accounts and 70% invested an S&P500 ETF or other index fund and retirement fund). If you have a higher risk tolerance, you should consider increasing the amount you have in the market (say, “age minus ten in cash, the rest in the market”). People with a higher appetite for risk/growth, can consider 110 minus your age.
Remember to first keep an amount equal to what you will need for three months (house and car payments, food, bills, entertainment) as this is a reasonable amount of time it could take you to recover from injury or job loss. You can always sell your investments (even at a loss) if you really hit an emergency and three months’ living cost won’t cover it. See:
Here is an allocation, if you are 30 years old with $15,000 saved up and you spend $1,500 a month on necessities like rent, transport and meals:
1
Three months’ savings ($1500 x 3)
Inflation-beating money market account
$4,500.00
2
Percentage of money left, equal to your age (30%) ($15000-$4500) x 30/100
Inflation-beating money market account
$3,150.00
3
The rest (70%) ($15000-$4500) x 70/100
S&P 500 ETF
$7,350.00
There are no rows in this table
Once you’re in the one-comma club (a net worth of at least $100,000) and you have more experience and risk tolerance, you can allocate around 1-2% of your portfolio into higher-risk investments. These could be buying shares in individual public companies, speculating on commodities (like oil or gold), crypto, or investing in small businesses through crowd-funded equity investments. If you’re in the two-comma club ($1,000,000 and above) your portfolio could get a little more adventurous.
What is the smartest way to start?
This is dealt with in future articles.
Mainly, you should make use of of all the tax advantaged investment accounts available to you. Many countries encourage people to invest, because they don’t want you to be a burden on the state in your old age. Some allow you to invest money that won’t get taxed in future; others allow you to pay less tax today (or get taxes already paid back) if you invest this way.
Many of these tax-beneficial accounts, such as pension/retirement accounts, have restriction— you can’t always choose what to invest in, the retirement account managers choose; others aren’t allowed to invest outside of the country; most don’t allow you to sell or withdraw your investments until you’re retirement age.
For that reason, most people will probably want to open a normal trading account; where you can buy and sell and deposit and withdraw what and when you want, albeit probably without a tax benefit.
See: and
Why the US market (if I don’t live there)?
It’s all about diversification, risk, history, and data. To me, it is absolutely insane that so many people will keep all of their cash, stock investments, assets, and real estate in one single market and currency, simply because they were born there.
Ask someone from South Africa to invest all their money in Malaysia and they would think you are insane. Same thing when you tell a Malaysian to only invest in South Africa. But both of them find it perfectly fine to keep all their money in “their” market, just because they were born and live there. It is still insane if you zoom out a little.
The companies tracked in the S&P 500 have operations all around the globe, effectively giving you exposure to those economies, too. If the US is going through a recession, those companies are still providing their goods and services in China and Japan and Europe and everywhere else.
As you become a more advanced investor over time, you can certainly consider investing in an index-tracking fund that will give you exposure to companies in a targeted region (such as “China”, “Europe”, or “all emerging markets”) or those in a specific sector (“healthcare” or “technology”).
For me, it’s a good enough place to start.
What about taxes?
In general, you need to pay taxes when you make money. If you earned a dividend, in most countries the investment platform will automatically deduct some and pay it over to your tax collector. When you sell your shares after a long time, you may have made a capital gain or a loss (which you either need to add to or deduct from your taxes). Again, your trading platform will probably calculate the amount that you gained or lost. Note that many countries give a tax break, where you don’t have to pay any taxes on capital gains up to a certain amount. Consult with your trading platform for more information. Once you have more money, you can always pay an accountant for assistance.
If you invest in low-cost index funds through a tax-beneficial account (usually a retirement or pension account; or a tax-free savings or investment account) you might not be liable for tax, or pay tax at a lower, when you finally decide to sell your index funds some years down the line.
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