Road to FIRE #4: Starting to invest

This could be your own story, if you’re willing to take a risk (credit)

Investing?! Are you insane?! That’s just gambling on the stock market!

Mentioning stocks and shares to my friends

Investing is a bit of an odd subject sometimes, depending on what group of friends I’m with. My colleagues at work (I work in the IT industry) seem to know what they are and are vaguely aware that their pensions are probably invested in some ‘funds’ or something and they’ll need them to grow a bit over time for their retirements.

My friends from back home (most don’t work in a ‘professional’ industry and are younger on average, but I am generalising here) seem to know that one guy who bought Facebook shares and made a mint when they went up but otherwise consider them the equivalent of heading to the casino and picking your favourite number on the roulette wheel. If it turns up, wahey! If it doesn’t, well, no biggie. More often than not though, it’s met with disinterest and considered something they can’t be bothered with.

Two quite different attitudes and yet somehow both completely wrong. Hmm.

What are stocks & shares?

There is actually a distinction between a stock and a share, but for this post I’m going to refer to them inter-changeably for simplicity. If you want to learn more, here’s a good resource on the difference. But in its simplest form, when you buy a share, you are buying a small (sometimes very small) piece of a company. That share can be bought and sold at will for whatever value someone is willing to sell it to you or buy it off you.

That share also entitles you to receive a dividend from a share (though not all companies return dividends to their shareholders). Dividends are payments from the company you have invested in, sort of as a ‘thank you’ for loaning them your money. These can be paid quarterly, bi-yearly or yearly. Dividends are generally paid out by well established companies, such as all the brand names you’ve probably heard of. While you could try and guess which shares in various companies are going to increase the most, there’s a much better and statistically (on average) more consistent way to buy shares: funds.

Funds & ETFs (Exchange Traded Funds)

A fund (and ETFs which are also funds) is simply a collection of company shares but instead of buying individual shares in each company, you purchase the fund instead. Buying £100 of Fund A would essentially allow you to buy several small pieces of company B, C, D & E which are included in that fund. This is know as diversification or as I put it – ‘not putting all your eggs in one basket’.

You may think Company X is the hot new thing you’ve been hearing about from your friends, but dumping all your money into one stock and crossing your fingers is just large-scale betting. And the odds are not on your side. It is better to have a small number of shares in each of a wide range of companies in various industries.

Taken to it’s logical conclusion – what if you had a small amount of shares in all the major top companies from around the world? Congratulations, you’ve just discovered one of the simplest and easiest ways to get started in investing and benefit from the world’s companies delivering ever better productivity and profits and paying you for the privilege.

Index Trackers

Buying a bunch of companies is far easier than you think (credit)

Simply put, they track an index. What’s an index? For example the FTSE 100 is an index which contains the top 100 UK publicly listed companies. In the U.S. the S&P 500 is an index of the 500 largest U.S. publicly traded companies. If you buy an ETF (a fund) which tracks the FTSE 100 then you are purchasing a small part off those 100 UK companies. When the UK economy is doing well, the share prices of these companies tends to rise and you benefit from this. And who cares if oil companies are having a rough time (BP, Shell) when you have all the other companies chugging along just fine. Diversification is good.

As these are well established companies you will also generally get paid dividends from the index tracker fund. Usually nothing incredible, but the FTSE 100 is currently yielding over 4.5%(!) if you look at the Vanguard FTSE 100 index tracker. That’s better than what you’d get in your savings account.

No guarantees

However, you must always bear in mind the phrase: “Remember that the value of investments can go down as well as up and you may get back less than you invest “. In the short term it is entirely possible you could lose half your money if there is a severe recession… like the one in 2008. The good news is these recessions don’t tend to last more than a couple of years on average and eventually your shares should bounce back.

But this is why investing has to be a long term game. You do not put money you may need in the next 5-10 years in the stock market. This is why you’ve built up your emergency 6 month buffer fund first. Being forced to sell your funds when they have dropped in value is how you lose money in the stock market. Do. Not. Sell.

Assume money you have invested is unavailable for the next decade. The rewards can be high, certainly better than stuffing money under the mattress, most likely better than a savings account, but you have to be prepared to take a risk to get anywhere in life. The stock markets around the world, on average, will increase over time faster than most other easily available options (cash / bonds / gold / property). The FTSE All-Share has returned on average 9.9% a year over the past 30 years. It is not a straight journey up though, there have been bumps along the way.

The returns of the FTSE All-Share over the last 30 years (credit)

If you’re still willing to take the risks to get ahead, then I’ll show you just how easy it is to get started in investing in the next post!

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