Tell me if this sounds familiar.
At some point earlier in your life, you had no sense whatsoever about your finances. For whatever reason – maybe a life change or maybe just a growing sense of maturity – you “woke up” and began figuring thing out.
You buckled down, got smarter about your spending, and perhaps got some debt collectors off your back. You started paying off some debt, too, and it felt good. Really good.
You have some goals in life. Maybe it’s to buy a house. Maybe it’s to have children. Maybe it’s to start a business. Maybe it’s to retire early.
Speaking of retirement, even if early retirement isn’t your goal, the idea of retirement in general is out there hanging over your head.
How do people achieve these things? They “invest.” At least, that’s the word you can’t help but hear if you visit mainstream financial sites or pick up a financial magazine. You’ve got to “invest” for your future.
But what does that even mean? And does it make sense in your life?
That little story probably seems familiar in at least a few ways – and probably in a lot of ways. It’s a very common story for people who made it through school without any real grounding or education in personal finance, but then find that their real experience in adult life makes it clear that they need to be making some smarter choices, only to find that trying to figure out those smarter choices is about as clear as mud.
Trust me, I was in the same boat not all that long ago. In fact, I started this site because I was trying to figure out everything about personal finance at once and I wanted to share what I was learning as I applied it to my own life. When I started The Simple Dollar back in 2006, that story sounded almost exactly like the situation and mindset I found myself in.
I wanted to make changes in my life. I’d made a few smaller changes and I found those changes to be incredibly empowering. I had some goals in mind, but I didn’t really know how to approach them other than “investing” – but I honestly didn’t know what that word meant.
Now? I’m well along the road to retiring early and I’m able to do it with a flexible career that gives me plenty of time to spend with my children. A big part of that change came from figuring out what “investing” is and then actually doing it.
What Does “Investing” Mean?
Here’s a very simple definition of investment: putting aside or spending something so that thing – or the item you bought with it – will be more valuable in the future. When you put money into a savings account, that’s an investment – you’re putting money aside with the idea that it will increase in value over time. Buying a home is an investment – you’re using your money to buy that home wit the hopes that it will increase in value over time, too.
Quite often, when you read about “investments,” the idea is that you’re investing money. However, you can invest other things, too – your time, your energy, your skills. For example, putting aside hours to study a subject that might help you in your career path is an investment of your time and your energy in the hopes that you’ll earn more money over the long run.
However, for the purposes of this article, we’re going to focus on a more specific definition. Investing means putting aside money or buying something with the purpose of selling or withdrawing it later when it has increased in value. Putting money in a savings account, even if it earns 0.1% interest, is an investment, in other words. Buying a share of stock is an investment. Buying a house is an investment. Putting money away for retirement is an investment.
Whenever you buy something with the intent of selling it later to make some money, you’re investing. Whenever you buy something with the intent of it earning money for you while you own it, you’re investing. Whenever you put aside money in an account that has the potential to earn any return, you’re investing.
Pretty simple, right?
Why Does Investing Seem Scary, Then?
There are a number of reasons.
First of all, there are many, many ways to invest. The sheer number of things you can invest in is almost limitless. You can buy shares of a company’s stock. You can buy sports memorabilia. You can put money in a savings account. You can buy a house to rent out to someone. It goes on and on and on. It’s kind of like walking through the freezer section of the grocery store and looking at the hundreds of varieties and flavors when the only thing you’re familiar with at all is vanilla ice cream. It can feel overwhelming.
Second, there’s an entire industry out there that tries to make money off of “helping” you to invest, and the only way they make money is if you’re confused and intimidated by it. Investing is actually really easy, but if everyone thinks it’s easy, no one would pay for financial services. Thus, the people in the investment world have a financial stake in making it seem complicated. They want to make it sound like you need to invest, but that investing is really confusing, so you need their help. (Frankly, it’s a load of crap. Anyone who isn’t a billionaire can easily invest for themselves.)
Third, humans are hard wired in many ways to be scared of investing. For one, people are extremely risk averse when it comes to their money. They’ll almost always take a dollar today over the promise of a couple dollars down the road. We spend a lot of our daily lives minimizing and avoiding risk, so the mere idea of putting our money at risk and not having it to spend right now seems far worse at first glance than it actually is.
All of these things combine to convince us that investing is a scary thing, something that we want to avoid until the last minute and something that we want help with when we do decide to do it.
What’s So Bad About an Investment Advisor?
There’s nothing strictly bad about most investment advisors. They’re just merely providing a service that we can provide for ourselves without having to pay their fees.
As I mentioned above, investment advisors are simply there to help people navigate a world that, for the most part, investment firms have worked to make appear as scary and confusing as possible. The truth is that, for most people, many forms of investing really are pretty simple. They’re only slightly more complicated than going to the bank and opening a savings account.
There are times where it does make sense to talk to a financial advisor – for example, when you have a large or complicated inheritance. I’d call an advisor myself in those situations. Financial advisors are good people who can be really useful in challenging situations; it’s just that your first steps into investment are not challenging.
What Do I Really Need to Know?
There are three things to think about with any investment that you make.
First, risk. Whenever you put money into an investment, there’s going to be at least a little risk that it might lose value instead of gaining value. That risk might be extremely tiny – to lose value in a savings account or a treasury note, for example, the United States government would have to collapse – but it’s always there. (It’s there even if you just hold cash in your hand, too.) Other investments have more risk – you’re risking that the company whose stocks you’re buying will continue to be a successful business, for example. You’re risking that the house you buy will continue to grow in value because it’s located in a nice neighborhood and is well cared for by the people living in it.
Second, liquidity. Whenever you want to get money out of an investment, either by withdrawing it from an account or by selling something, it’s going to take some amount of time. Some things are very liquid, like savings accounts – you can basically take out your money whenever you please. Stocks are also fairly liquid as the company through which you invest in stocks (your investment house) will help you find a buyer for those shares quite quickly. Other things, like a house, are less liquid – it will take you some time to prepare a house for sale and then sell it. Generally, lower liquidity is seen as a disadvantage if you assume that you’re going to want to sell it in the future.
Finally, return. How much money do you expect to earn on this investment each year? A savings account can be expected to return about 0.1% to 1% per year. An investment in stocks returns, on average, 7% per year – but that’s an average (remember the “risk” part – there are years when it is going to be above that and years where it’s going to be below that). An investment in a house is going to vary depending on the local real estate market – anywhere from 0-1% to 10% or more depending on what’s happening there. This is the part that usually requires some homework and a little bit of guesswork.
Most investments succeed in two out of three of these areas.
Savings accounts, for example, are great in the risk department (very low risk) and the liquidity department (very high liquidity), but aren’t good in the return department (very low return).
Stocks, for example, are great in the liquidity department (pretty high liquidity) and the return department (a very nice return on average), but are pretty bad in the risk department (you can lose money in individual years and even over multi-year stretches, while other years are really good).
Buying a house is great in the risk department (pretty low risk – they will go up in value) and the return department (usually a solid return on investment), but are pretty bad in the liquidity department (if you’re trying to get a decent return, it can take quite a while to sell a house).
So, which of the three factors should be the one you care about the least? Well… onwards to the next question!