You know you need to invest so that you make your money work as hard as you do. BUT, so many options and opinions and sometimes it’s so overwhelming you just decide to put your money under your mattress and hope for the best. Let’s breakdown a few of the most common ideas when it comes to investing.
Compounding is the idea that your money should make money for you. In the most basic sense you let the bank use your money to lend to others and therefore they pay you a fee, interest. Now you have your original balance plus the interest to loan them and you make interest on that. The cycle continues until you pull the money out. The same process can happen with stock and here is an example from Investopedia:
An investment of $10,000 in the stock of Apple (AAPL) that was made on December 31, 1980 would have grown to $2,709,248 as of the market’s close on February 28, 2017 according to Morningstar’s Advisor Workstation tool. This translates to an annual return of 16.75%, including the reinvestment of all dividends from the stock.
Short Term vs. Long Term
Are you investing for the short term or the long term? Most professionals will say only purchase stocks if you are investing in the long term so it gives you time to ride out fluctuations in the market. Short term is generally defined as 5 – 8 years while long term is beyond that. Retirement is a long-term investment, saving for a new car is short term.
Long term is considered prudent for retirement investing because it gives you the opportunity to buy consistently over a period of time. It also allows you to enjoy the bull markets and purchase at lower prices in the bear market. If you only invest in the short term you could possibly be pulling out to the market at the wrong times and therefore decreasing your returns.
Think about the Monopoly board game. If you put all your money in purchases the block at Park Place and setting up hotels you only have one chance each time a player makes it around the board to take collect money. If you have a property on each side of the board you increase the chances a player will land on your property.
Diversification of stocks is the same concept. Stocks make us companies and companies come in all shapes and size. Large Cap are mostly made up of large multi-national companies while Small Cap have a small capital footprint. International stocks are companies that originate outside of the US and are listed on the US stock exchange. Just like you would increase your chances by having a property on each side of the Monopoly board you will diversify your risk if your portfolio is made up of different types of stocks.
Continue the conversation with us at our podcast where we talk to Bobbi Rebell author of How to be a Financial GrownUp.