The landscape of “investing” can be a daunting and scary prospect to many novice investors. But I’m about to drop a bomb…it doesn’t need to be. It can be really simple if you understand the basics.
The investing world can be dynamic and evolving all the time. The good news is we are going to make the process easy. It will take some time and effort to grasp basic concepts, different assets and liabilities, what, where, and how much to invest, etc.
The basic definition of “investing” is to allocate your money, expecting greater future returns. There could be various asset classes where you can invest money, which results in the appreciation of capital or your investment generating income for you over a period of time.
THINGS TO CONSIDER BEFORE INVESTING
A few basic questions anyone who wants to invest needs to answer are:
1. Do you have any high-interest debt?
If your answer to this is yes. Then, you must first work on getting that squared away as soon as possible. You can add extra money to your monthly payments to get that down before the loan term. If the type of your debt is a credit card, you need to erase that debt immediately because credit cards charge interest of 14-30% depending on your credit score. If you clear that debt, you are automatically earning 14-30% on money. So, reducing the high-interest debt you owe is a good place to start.
2. Do you have an emergency fund?
You are good to invest if you have an emergency fund to cover your expenses for 3-6 months. If not, you need to work on building that right away. Because investing is considered for long-term goals. If you take the money out of the investment in the short term, you won’t be able to reap the fruits of compounding. So, an emergency fund plays a crucial role before investing.
3. How much can you afford?
You could invest as little as $1 per month with applications like Stash or invest spare change from your credit card transactions using Acorns for a small fee. But, the big question is how much can you afford? If all the money from your paycheck goes to your payments and living expenses, you barely have money to invest. This allows you to get creative. You can earn some extra money by picking up a side hustle.
WHY INVEST?
Holding your money in a checking account is good for your everyday expenses and savings account for emergency funds or any other short-term goal like a down payment for a house, vacation, etc. But, over the long term, these accounts will eat up your money because the purchasing power decreases yearly due to inflation (rate of increase in prices over a given period).
For example, in Dec 2022, a traditional savings account offered 0.1-0.5% APY. A High-Yield savings account was offering 3-4% APY. With inflation at 7.1%, you were losing money.
On average, investing the same amount of money in stocks earns a 9-11% return per year over the long term (based on stock market returns from decades).
Let’s consider you earn a mere 6% on your money; it still beats inflation by 4% (historical average inflation is 2%, so 6-2=4%), which you can re-invest, and that money, in turn, works hard to generate more money. Personally, I recommend you to save 3-6 months of expenses and START INVESTING ASAP. The earlier, the better.
You can refer to my previous blog post – Savings vs. Investing if you need further clarification.
INFLATION AND DEFLATION
Inflation is the rate at which the currency loses its purchasing power over time. The value of goods and services increases over time, but the currency’s value is reduced when inflation rises. Deflation is in contrast to inflation. Deflation causes the prices of goods and services to decrease when the currency’s purchasing power increases.
RATE OF INFLATION – LOSING MONEY
For example, in recent decades, let’s consider the cost of purchasing a cup of coffee; you can see the purchasing power of currency.
Year – Price of Coffee
1960 – $0.20
1970 – $0.25
1980 – $0.45
1990 – $0.75
2000 – $1.96
2010 – $1.50
2015 – $2.70 (on average)
This shows the value of the Dollar reducing over time. This is because of inflation.
TYPES OF INFLATION
There are three different types of inflation:
1. Demand-Pull inflation
2. Cost-Push inflation
3. Built-in inflation
Inflation can be considered positive or negative depending on the rate of change. Inflation eats away the value of the Dollar that you have in your bank account. Inflation impacts a lot of products and utilities like metal, food, electricity, etc., and services like entertainment, healthcare, etc.
The loss in dollar value would impact the average cost of living for a common man, which in turn impacts the country’s economic growth. For this very reason, monetary authorities like the Federal Bank or Central Bank (varies with the country) keep the supply and demand of money in check to keep inflation in check and allow only permissible limits to keep the economy running smoothly.
If inflation is not handled properly, it could result in an economic downturn like in Venezuela. There’s hyperinflation, which is causing socioeconomic and political crises. The Central Bank of Venezuela (BCV) officially estimates that the inflation rate increased to 53,798,500% between 2016 and April 2019 (source: Wikipedia). The average inflation rate in the United States from 1990 to 2018 was 2.46%.
Inflation is a very big topic to discuss, but for this post, you can keep in mind that inflation erodes the dollar sitting in the bank. We can dive deep into this in another blog post if you need further clarification on Inflation.
