In this first edition of The Next Wave, I wanted to dive into the fundamentals of investment and the tools I use. However, I received many messages last week of people worried they don't have enough money to invest. Don't worry; I faced the same barrier for years! And it prevented me from investing too.
- Winners and losers in the economy
- Compound interests
- What if we start investing today?
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The thing we need to invest in the stock market is… money. And it is to make more money we wanted to invest in the first place. Most of the time, we think we don't have enough, and it becomes an excuse that prevents us from investing. It was also my excuse. But then I learned a counter-intuitive fact about the financial market: it's not linear (more on that later). Therefore you don't need tons of money. You can start investing with as little as $200 a month and make significant returns. The most important: be consistent.
Today I want to highlight two facts that convinced me:
- $200 a month is enough to start investing in the stock market
- The stock market is one of the best available options to invest in.
These two facts are compound interests and policymakers.
1. Winners and losers in the economy
“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”
Winston Churchill - The End of the Beginning
The general idea is that the economy runs in cycles (with periods of growth and recessions). Every time there is a crisis (such as the current COVID outbreak), policymakers have two options: lower interest rates or print money to sustain the economy. Understanding these principles is fundamental for an investor. I recommend you watch this video by Ray Dalio, where he explains how the economic machine works. I also suggest you read his publications on LinkedIn.
Policymakers try to save (or at least stabilize) the economy. By economy, they usually mean large companies (such as banks) and the financial markets. However, financial markets are not a perfect reflection of the real economy, especially during economic crises.
The United States government is now explicitly in the business of choosing winners and losers in the economy. As usual, winners are the owners of financial assets. As usual, those who do not own financial assets are losers.
Therefore investing part of our revenue in the financial markets seems to be a good idea. It has been appealing to me for a long time. I've read about stocks and commodities but also real estate, foreign exchanges, and even bitcoin. However, the same false idea hit my head every time: I don't have enough money. "If I invest $100 and double it, which is a huge performance of 100%, I will only make another $100. Which won't change my life".
But I never took into account the essential factor:
2. Compound interests.
Let's take an example: the S&P500 has a median average return of 12% (not corrected for inflation) since its inception. The S&P500 is an index of 500 stocks taken from the NYSE and the NASDAQ. So if you invest in an S&P500 tracker (an entity that follows S&P500 performance), it is as if you invest in 500 different stocks meant to be a representation of the health of the US market. You can achieve 12% a year without any stock picking. Source: Wikipedia
Do you think 12% a year is not that big? Well, think again:
Consider a mutual fund investment opened with an initial $5,000 and an annual addition of $2,400. With an average of 12% yearly return of 30 years, the fund's future value is $798,500. The compound interest is the difference between the cash contributed to investment and the investment's actual future value. In this case, by contributing $77,000, or a cumulative contribution of just $200 per month, over 30 years, compound interest is $721,500 of the future balance.
The amount of money we allocate is an essential factor in our future balance. It is the elephant in the room. Yet most beginners forget another factor: time. Warren Buffett built his fortune on compound interests: he decided to play the long game instead of gambling on short-term lottery winnings.
“Wealth is assets that earn while you sleep” – Naval
3. What if we start investing today?
I decided to invest $200 a month in the stock market.
I will make two $100 investments a month and write about it. You can track what I invest in and learn why I did it (which does not mean I made the right call, so you will also learn from my mistakes :) ). Spoiler: the first will be before the end of the month.
I take for granted that you can invest at least $100 a month in the stock market (2x$50 investments). If you can't afford it, multiple articles explain how to save money, so I will let you read them: here, here, and here. Just keep in mind that the personal finance game is only three steps:
Step 1 = Earn Money
Step 2 = Spend Less Than Money Earned
Step 3 = Use The Difference To Increase Money Earned, Or To Decrease Money Spent
- Think about your career. Try to advance it so that you earn more money.
- Take a second job to earn more money. (Side hustle might be the best marketing trick ever. Side hustle = second job)
- Collect returns from your investments.
- 101 Ways To Live Like A Poor Hermit.
- Pay less tax.
Using The Difference
- Pay down debt. (this is the same as investing, it’s all allocating capital effectively)
Or to summarize: (i) generate free cash flow, (ii) allocate capital effectively. In this newsletter, we will try to become an expert in step (ii).
Suppose you do the same, in 10 months, we will have invested in 20 different companies, commodities, or indexes: A well-diversified portfolio (we will talk about diversification later).