Getting Started Series Part 5- Introduction to Investing

Getting Started Series Part 5: Introduction to Investing

This is a series intended to answer the question “I’m covering my bills, now what?” It’s for people who have a steady source of income and have a vague notion that they should be doing something more with their money, but don’t really know how to begin. This will go through what to do with that money post-bills, from setting up an emergency fund, to debt management, retirement, and investment. Although most of this information is applicable to civilians, we’ll also be providing resources and information specifically geared toward military servicemembers and their families.

Let’s recap on our series so far. Once you are covering your bills, your first step is to set up your emergency fund. The next step is to pay down your debt , although we also discussed why it’s advantageous to carry some debts and invest the payment. After debt has been managed, the next step is to set up and contribute to your retirement accounts, which we wrote about here and the military’s TSP retirement account is addressed here. Once that has all been achieved, you can turn your eye toward investing. Furthermore, much of this investing information will apply to your retirement accounts as well. So even if you aren’t ready to open an individual investment account, you’ll hopefully still find much of this information to be useful.

Investing is using money to make more money. Doesn’t that sound nice? There are many ways that this can be done, with varying degrees of effectiveness and effort.

You could argue that your savings account is an investment. But at .000001% interest rate (okay, okay, I’m exaggerating, but just slightly) it won’t net you very much money. So a savings account, while great for an emergency fund, isn’t going to be a money generator. Alternatively you could invest in a Money Market account, but again it won’t be a money generator.

One form of investment could be purchasing real estate for rental (the house you live in doesn’t count). There’s a lot of mixed opinions about real estate as an investment (here’s a great article against real estate and here’s a pro article). I am personally undecided about whether or not I think real estate is a worthwhile form of investing and it probably depends on the area as well. However, I would argue that it’s not the best option for military families. With all the frequent moves it would be very difficult to keep an eye on your property unless you have family or a trusted friend in the area that could help you.

Some people invest in small businesses. This could either be your own business that you start, or it could be buying an established business or franchise and either actively managing it or hiring a manager to run it for you. You could also just buy part of the business. Again, this could prove to be more difficult with frequent PCSing.

Although those are great options for many, we are going to be focusing on stocks and bonds. Why? Unlike real estate or buying a business, investing in the stock market is not a large time investment, meaning it doesn’t take a lot of your time and labor. And in fact, if you invest in index funds (a topic we are covering in Part 6!), you’ll be able to just let your money sit for years or decades with very minimal interferences on your part. To me, that really captures the idea of putting your money to work so you don’t have to.  Furthermore, stocks and bonds have proven to be a great financial investment over the last century, despite the crash of 1928 and other recessions that you may hear in the media. In fact, according to The Neatest Little Guide to Stock Market Investing, “The stock market has returned about 10.5 percent a year for the past 75 years or so. Corporate bonds returned 4.5 percent, U.S. Treasuries returned 3.3 percent, and inflation grew at 3.3 percent.” (p 3)

When people hear the stock market, I think they picture something like this:

 

Either that or movies like The Wolf of Wall Street and Blackhat. Combined, these don’t paint a very nice picture of the stock market.

But the stock market (or bond market) doesn’t have to be intimidating at all. So let’s break it down.

When you buy stock, you buy ownership of a company. This small piece of ownership is called a share, and is likely a very small piece of the company’s pie. For example, Apple has over 5 billion shares. So if you buy stock in Apple and bought 5 shares, you’d own 1 billionth of the company. Buying stock in a company and therefore becoming a part owner means that when the company makes money so do you. In fact, when companies are profitable, they will pay their shareholders (the people who own stock in their company) a dividend, or a portion of their earnings.  This is one way that you can make money through the stock market, by earning dividends. You are often given the option of taking the dividends or reinvesting. At this stage in my life I always reinvest, but if I was well into my retirement years I may look into just taking the dividends.

Stocks are also sometimes called equities because you own equity in a company, similar to owning equity in a house. If you buy your house for $100,000 and over time it becomes worth $150,000 then you have $50,000 of equity in your house. Stocks work similarly. If you bought stock in Company X for $10 per share and it grows to be worth $110/share, then you have $100 in equity per share that you own. This another way that you can make money from stocks- by trading away shares at a higher value. This is called capital appreciation when you sell your stock for a higher value than what you bought it for.

Bonds are loans of money, with you as the bond holder serving as the bank.  Governments, municipalities, and corporations may issue bonds to fund certain projects. For example, schools and airports are typically built with money from bonds. In return, the bond issuer agrees to pay a certain interest rate and to return the principal amount loaned by the end of a certain time period (called maturing). Like stocks, bonds can be bought and sold before they mature. And like stocks, there is a bond market for this trading of bonds. Bonds are an important part of your financial portfolio because they guarantee a certain return and are considered more “safe” than stocks as they tend to be less volatile in their nature. Additionally, they tend to match or beat inflation which is why they are a great choice if you are focused on wealth maintenance rather than wealth growth.  However, bonds are not a risk-free venture. There is a risk of default, meaning that the issuer does not repay their bond. There is also a risk of inflation, in which your money when returned is worth far less than when it was loaned out. Changes in interest rates can also affect the prosperity of bonds. For further reading, Jlcollinsnh has a great post that does a great job explaining bonds and their risks.

There are two schools of thought in investing in stocks and bonds- active or passive investing. Active investing is picking individual stocks or bonds that you want to invest in (such as choosing Apple or Google). Passive investing is choosing mutual funds or index funds which allow you to own from a variety of companies.

Now that we have the basics of investing and the stock and bond markets, we’re ready to look at mutual funds and index funds.  Be sure to come back for Part 6 of the Getting Started Series in which we will discuss why we favor passive investing and why we invest almost entirely in index funds.

 

 

 

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