Finances, barely-an-adult style(Part 2)

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In the last post we talked about budgeting, having an emergency fund, then how compound interest works as a basic principle and how it’s like growing an apple tree instead of having to plant and grow carrots every year. And how compound interest is a huge reason some people end up on the streets, while others end up rich.

(Check out the last post here:
https://www.adultingtoadulthood.com/podcast/2018/11/28/finances-barely-an-adult-stylepart-1 )

This time around we’ll be looking at investing, because this is where compound interest REALLY takes off. I’ll explain what a stock, bond, and dividend is and how they can help not only the rich, but the average person earn some serious money without actually having to work for it. I’m sure you’ve heard the saying “you have to have money to make money”, right? Well, I was surprised just how true that statement is….

Let’s start with why you should care, what compound interest and investing have in common and how that turns your little stash of money in to a respectable hill of gold. Compound interest is an occurrence that happens when you earn money on the money you previously earned from interest, and when you invest it’s the same thing, if you leave the amount of money you earned from investing in your account you can then earn money off of that amount on top of what you earned before.

Let’s do a bit of math, assuming your ROI(Return on investment) is 10% a year, which is a bit high but the math is simpler using 10s. If you can only afford to stash away 1000 dollars every year in to an investment account(just 20 dollars a week), you’ll be earning 100 dollars your first year off of that investment, followed by 210 the next, followed by 331 the next, followed by 464 the next, followed by, followed by, followed by…. As you can imagine it keeps growing til you hit a couple of major milestones that ramp up and multiply. The first being what I call the point of take off, when your money is earning as much as you’re able to put in to it every year. So when your earning 1000 dollars every year it’s like having 2 people now putting money in to your account every year. The next milestone, which now comes faster than the last is when your account is earning 2000 per year and it’s like having 3 people putting money away. The milestones at this point happen faster and faster and suddenly you’ll find yourself in your mid 40s and your pile of money is earning more money on it’s own than you could afford to put in to it. Your money is growing on it’s own, and it’s out earning you. That is compound interest, that is the effect of stashing away just 20 dollars a week in to an investment account.

Ok, we’ll talk about the bare basics and explain how investing works. An investing account will be made up of stocks and bonds, and you’ll earn money by selling/holding those, while also being paid dividends. Sounds like a lot right? Give me a second to explain.

Starting with stocks, a stock is a tiny portion of a company that you buy and hold on to. Typically each share isn’t a big percentage of the company, but if you had enough money you could buy up enough stocks to influence major business decisions, though most people will just hold on to them long enough to sell them again for more money than they originally paid for them. Here’s an example; say you bought 1 share of google when its price was 900 dollars a share, you see they release some new product and the company as a result is bigger and more valuable so it’s share price increases to 1000 dollars a share, if you sell your share now you’ll have earned 100 dollars off the difference. This is generally how money is made from stocks, you buy up portions of companies, and then sell them later down the road when the company is worth more than back when you bought it.

Moving on to bonds, a bond is basically a loan you personally give out that you’ll be paid back on when it matures, or reaches a certain amount of time as agreed upon. Here’s an example; My mother bought 1000 dollars worth of Canadian bonds(loaning money to the government) that matured in 10 years, when she was allowed to cash them in for the agreed amount. Typically bonds don’t earn as much money as stocks do, but they’re also far less risky as well. Their advantage being that you don’t have to try and predict the future like you do with stocks.

Finally, what are dividends? Well, when a company earns money, they can do a few different things with it. They can use that money to reinvest in the company by buying more supplies, hiring more employees, spending it on marketing, etc. Or they can share the money out with the share holders, which is what a dividend is. It’s a portion of how much that company earned, that’s given to you as a person who owns some stock in the company. The more shares you own, the more money you’ll be given in dividends. So If you owned 1 share of google and I owned 2, and their dividend was 20 dollars, you’d be given 20 dollars and I’d be given 40. So buying and holding on to companies that pay out dividends is another way to earn money as an investor.

When you begin your investment journey however, I suggest jumping in to mutual funds. A mutual fund is a managed set of stocks/bonds set up by a bank to generate a desired type of return. So if you go to your bank and ask to start a mutual fund investment account, you’ll be met with fees(usually a % of the total amount in your account) but you won’t have the initial headache of learning how investing works. Paying someone else to manage your money means you’re going to see smaller earnings, but you’ll have a qualified expert in your corner. Later in life, as you learn more about investments, you can branch out to making your own stock picks and such, but I suggest you get started at your bank with a managed fund. Whatever it is you decide to do, just get started today. The sooner you start, the sooner you’ll hit that point of take off where your money starts to sky rocket off without you.

In the next post I’ll talk about the basics of risk. When you’re investing, how do you know what’s gambling and what’s actually investing? And staying on theme I’ll also mention insurance and how your risk tolerance should curve off as you get older. Knowing where it’s ok to play with a little risk and where it isn’t, is the key to keeping yourself out of trouble. But that will have to wait for next time.


This weeks advice

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