What Is Investing?
What investing is, and why you need to do it. It’s easier than you think. Updated March 30, 2024.
At the beginning of my adult life, I knew nothing about investing. I put in and took out money from a bank account, and that was all I knew. I also knew that I needed to start a retirement account – and that I should have done it yesterday – but had no idea what such a thing entailed.
At my first full-time job, my workplace opened a retirement account for me. I had no idea how it worked or what was in it. I didn’t look into it because I assumed it was really complicated (apparently more so than the astrodynamics software on which I happily started working). I knew that my employer contributed money into this account, and I was supposed to as well, but I didn’t. A few years later, however, I fell into a months-long bout of furious research on the topic of investing, devouring books, websites, articles, and forums.
I came up for air, stunned at how unbelievably simple investing is. It requires no knowledge of higher math or finance: if you know how to open and use a bank account, you can open and use an investment account. It is such an essential life skill that we should have learned it in high school. I, and most people, wasted so many years avoiding this important life task due to a mistaken belief in its incomprehensibility.
In a flurry of activity, I looked into my workplace retirement account and modified the investments in it. After deeming this account to be not the right kind for my life goals, I opened my own retirement account outside of work, as well as a regular non-retirement investment account. After coaching a few friends – highly educated people who were needlessly wary of the topic – on how to get started, I decided to write a piece that would be “the world’s easiest guide to investing.”
So, let’s talk about investing.
I have a bank account that I save money in. Isn’t that good enough?
That’s good, but you can do better. You probably know about this thing called “inflation”: the cost of things slowly creeps up as time goes by. Therefore, the money you save in a regular bank account will gradually lose its value – by being able to buy you less and less – as years go by.
Most bank savings accounts will give you a tiny bit of interest (no more than 1%) on the money you store in it, but that amount is nowhere near enough to make up for inflation. The average rate of inflation in the USA is about 3% every year (meaning that something that costs $1.00 will cost $1.03 the next year). As of this writing, I have not come across a bank savings account that will give you 3% interest on your money (which would turn the $1.00 you saved into $1.03 the next year).
Where can I put my money so that it doesn’t lose value over time?
You will use your money to buy tiny portions of companies, called “stocks” or “shares of stock.” These companies will use your money to make more profits, of which they will give you a tiny bit, called “dividends.”
The profits you get back from stocks are on average 10%, which is much higher than the average rate of inflation, 3%. This means that not only does your money not lose value due to inflation, you also make more money.
Isn’t investing in stocks really risky?
Stocks are really risky if you do what a lot of people do: try to guess what new company is going to be the next big hit like Apple or Google, buy shares of that company, sell the shares for profit when you think they’ve hit a high price, or agonize over whether to sell the shares or hang on to them when their value drops below what you paid for them. This is not too different from gambling in a casino; you will most likely lose money, or break even if you’re lucky. I really don’t recommend doing this.
Instead, you will buy shares of something called a “stock index fund,” which contains hundreds or thousands of companies. Instead of buying shares of one company, you buy shares of an entire stock market. Over time, some of the companies in the stock index fund of which you bought shares will go down in value, some will go up in value, and most will make profits – you don’t have to worry about the performance of any individual company. One single company can go bankrupt and disappear, but an entire stock market will not, unless the entire country’s economy disappears (in that case, you will have far greater concerns than the performance of your investments).
The purpose of investing is not to play risky games in hopes of a lottery-like windfall, but to maintain the value of your money over time despite inflation, while making a modest amount of profit.
But the stock market sometimes crashes!
Of course it will. And then it will rise, then go back down, over and over again for years on end. Here is what you will do to maximize the chances of ending up with more money than you started with:
- Hold on to your shares. Ignore scary news headlines about the stock market crashing, one country going to war with another, or a new president coming into office. Do not sell your shares until the day you are ready to start living off of your investments. The long-term trend of the stock market is to increase in value (7% each year on average) despite dips and rises along the way. The only way your invested money can increase in the same way is if you hold on to your shares for as long as you can, through all the dips and rises.
- Keep buying more shares. Every year, your shares of the stock index fund will pay you dividends – fewer in lean years, more in profitable years, but you will always get some payout every year. You will set your account to automatically use those dividends to buy more shares, which will start giving you dividends each year, and so on. This is called “reinvesting.” In addition, whenever you have more money you can put away, you will buy more shares. Do not try to “time” the market by waiting to buy shares when you think they’re at a low price; simply invest as soon as you have some money to do so.
I’m not rich. I don’t think I have enough money to do investing.
I like to use what I call the “lost from wallet” test: if I lost a $20 bill from my wallet, I’d be disappointed, but only briefly, and my daily life will be negligibly impacted. Figure out what that amount is for you, and how often you can “lose” it – that is the money you can put away for long-term investing. (Except that you’re not losing that money, and it will grow in value!)
If you’re already saving money for the future in a bank account, you might as well save some of it in an investment account, where your money can make more money for you. (Personally, I don’t save money in a bank account anymore, except for just enough to pay bills. I use my investment accounts as savings accounts.)
Resources
“The Intelligent Investor” by Benjamin Graham explains investing in the clearest, most common-sense way I have ever seen. After working my way through the current list of best-selling investment books, I marveled at how this one – the oldest of them all, first published in 1949 – remains more elegantly and simplistically written than almost any book published since.