Stock Market 101

Once your debt is gone, the fun part really begins. It’s time to invest! All the money you were using to clear up your debt is now free to invest, as well as any money leftover after the essential food, housing, etc. It is not time to go on a shopping spree, or plan extravagant vacations, or buy a new, expensive car… unless you were hoping to repeat the debt cycle.

Instead, invest your money, and have your money make you more money. Really think about this last sentence a bit. By investing your money, your money actually WORKS to make you more money, with no additional effort required on your part. This is much different than just having your money sit in a bank, and completely opposite of spending and wasting your money on the latest and greatest toy. Once I finally grasped an understanding of this, it was truly eye-opening.

It took me a while to get into the investing world because everything I had heard about it seemed so complicated. I didn’t know where to begin, how the stock market worked, or what all the fancy terms meant. I literally thought investing was the same as gambling at the casino, except more widely accepted and without the negative stigma. I was very wrong. Investing is easy, and less risky than gambling at the blackjack table. And I’m going to make it super simple for you. To invest, all you need to know is Vanguard.com, and VTSMX or VTSAX. My next several posts will be the “How To Invest” posts; this post will shed some background about investing in the stock market.

Stocks

For now, we will look primarily at investing in stocks, and deal with bonds much later. When you invest in a company’s stock, you own a share of that company. When you invest in a bond, you let a company borrow your money and in return they pay you interest on the loan, and eventually you get your money back. Stocks are more aggressive and can yield higher returns. Bonds are safer and yield lower returns. Stocks are good to make you money to get you closer to retirement. Bonds are good when you are closer to and are in retirement to smooth out any ups and downs the stock market may experience.

Stocks make you money in two ways, through capital gains and through dividends. When you invest in a company’s stock, you own a share of that company. If the company becomes more valuable compared to when you first bought that share, you make money. This is known as capital gains. If you bought the share for $100, and tomorrow the company’s value increases 10% and the stock price becomes $110, you make $10. If you had invested $200, you own 2 shares of the company. When the company’s share value increases to $110, you would have made $20. If you own 100 shares of the company, that $10 increase in the share will mean you made $1000. Imagine if the company’s share had increased by not only $10, but by $30, or $50, or more! Easy money to be made. However, when you sell your share to get the profit, you will owe taxes on it. That is why it is more beneficial to buy shares and hold it for the long term. And by long term I mean from now to during your retirement years. When you choose to reinvest your capital gains, you experience the magic that is called compounding. Compounding is what makes retiring early possible, especially if you choose to start investing now versus later. Take this scenario – Year one: you invest $1,000. You choose to reinvest the 10% capital gains. Year two: you now have $1,100. In year two, a 10% capital gains means now you make $110 instead of only the $100 from the year before. Another reinvestment of the 10% capital gains means in year three, you now have $1,210. By year four, $1,331 is now yours. And so on and so on. Your invested money has worked to make you an additional $331 in 4 years. Don’t forget, this is pretending you’re ONLY investing $1,000 at the beginning of year one. Continue to invest a portion of every paycheck, month after month, year after year, and you get the picture. Are you getting excited yet?!

Dividends from stocks work pretty much the same way. Dividends are payouts that a company issues to investors, usually every 3 months. The company literally gives you money just for investing in them. If you own 100 shares and there is a $0.25 dividend, you get $25. Choose to reinvest this also instead of getting a check in the mail, you experience the magic of compounding yet again.

So Much Better than Casino Gambling

Sure, there is risk involved with investing in stocks. But, you can definitely minimize the risk that is involved. First, you can do this by never trying to time the market with individual companies and stocks. It is hilarious how often you hear market analysts on new channels and business websites try to predict the ups and downs of the market or the next up-and-coming company, and how often they are wrong time and time again. They’re bound to guess right sooner or later! You hear stories of legendary investors that pick a winning company and make millions off of it. But, there is a reason you hear about these investors and know these stories – it doesn’t happen often at all. If you could time the market and predict which company will be the next big deal, you too would be famous. It’s not going to happen, save your money instead. If you hear about an up-and-coming company and are thinking about investing in it, chances are you already missed the opportunity. Instead, invest in index funds.

By investing in index funds, you are investing in a slice of a number of companies just by owning one share of that index fund. For instance, we will be using VTSMX or VTSAX (more on this later). VTSAX is made up of 3,604 companies. 3,604 of the biggest companies, medium sized companies, and small companies. By owning 1 share of VTSAX, you own a little bit of all 3,604 companies. If one of those 3,604 companies goes bankrupt, they are replaced in the index by the next company in line. That is the beauty of investing in indexes.

Another reason investing in stocks is much more than just gambling is you can see historical trends. Check out this chart of the Dow Jones Industrial Average, one of the oldest stock market indexes:

Dow Jones

It always trends up. I’m sure the Great Depression was a scary time, but the stock market recovered and up it went. Despite the several crashes since the creation of the Dow Jones in 1896, innovation, technology, and business must go on and the stock market recovers. The only way you lock in a loss is if you sell your shares after a market dip. This is why it is extremely important to never sell during a crash! The market will recover, you will recover your losses, but ONLY if you still have shares in the market. If you sell your shares because you afraid of the market going lower, your lost money is gone forever and you will miss your chance recover when the market rebounds. If you are an emotional human being – invest your money in the index fund, forget about the investment and don’t watch the market, come back to it years later and celebrate how much closer you are to retirement. This way, you won’t let fear take over and sell if there is a dip. Investing will be rocky ride and crashes will be inevitable. You must be strong, stay the course, and let the stock market make you rich.

Please feel free to comment or ask any questions. What scares you the most about the stock market? Don’t forget to subscribe to continue on this journey with me! Next up we’ll talk about the basic structure of the investment game: 401k, traditional IRA, Roth IRA, and more!

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