This is Investing 101: Learn the basics how to invest money smartly, increase wealth and create passive financial income.
„The compount interest effect is the eighth wonder of the world. Who understands that, will profit. Who doesn’t understand that, will pay for it.” – Albert Einstein
This quote can literally change your life! If you understand the power of the compound interest effect, you will definetely put more effort into your financials. Ignoring this topic on the other hand means you lose money by inflation and debt or by making bad decisions.
One fact beforehand: Investing is not only for rich or older people! It does not matter if you’re still student with a lack of money. Unless you’re living in a third world country you should be able to put 25 € per month aside to invest in mutual funds.
How to Start Investing: Why You Should Start Investing
When you want to learn how to start investing the question that arises is, why you schould start investing at all? Besides having some money left in the end of the month to save it for the future, there are three main reasons why your money should work for you:
Why You Should Start Investing: Inflation Protection
Inflation is defined as a continuing rise in prices caused by an increase in the money supply and demand for goods. Put simply, the value of your money is decreasing over time. As central banks print more and more money due to commercial policy, there is more money available but the amount of products and services do not grow in the same way. If you bought a beer for 4€ last year, maybe the price has already changed to 4.50€ this year. According to the OECD databank, the yearly prices grow in average by 3,8% (2019: 2,0 %).
Investment in certain assets can protect you from inflation since their prices grow with the inflation.
Why You Should Start Investing: Passive Income
Instead of losing money, wouldn’t it be better to gain more money yearly? The principle is quite easy: You own a surplus of money which you do not consume today and you borrow it to someone else temporarily who needs the money right now. In return you receive lending fees, e.g. interest rates, which will increase your income later.
For example: You buy a security for 10.000€ which generates a return of 8% per year. After 10 years your invested money has more than doubled to 21.600€, without doing anything. Alternatively, you can save up a higher sum and get paid out in dividends yearly.
Why You Should Start Investing: Retirement
In most western countries we observe an increasing older population which will result in a pension deficit. People simply won’t have enough money at retirement age. You can protect yourself against old-age poverty when you invest little cash attributions in a young age to profit from the compound interest effect.
How to Start Investing: How much of your money should you invest
Rule No. 1: Don’t invest money that you don’t have (by credit) or that you need in the near future. Beyond that, if you’ve already saved up some cash on your bank account you can invest a higher sum immediately. Keep in mind that you need a security reserve for emergencies, e.g. some cash if you’d lose your job. Roughly, you should have a cash reserve about three times of your monthly net income. This money should be put on a savings account (overnight deposit account) so that you have instantly access.
Everything that’s left over can be invested in long-term assets like stocks, bonds, real estate etc.
If you want to invest a fixed sum on a montly basis, e.g. the leftover of your salary, the investment amount depends on your income and lifestyle. Generally you shouldn’t spend money for things you don’t need or things you cannot effort. Personally, I get inspiration from the reddit community >Frugal Living< to keep the high quality of my lifestyle but still save money. With these ideas, you can find ways to invest at least 25 € monthly, even as a student. With an higher income you should invest about 30 – 50 % of your salary. An average employee with a net salary of 2.000 € should be able to invest about 600 € monthly after setting up a security reserve. When your salary increases in the next years, don’t consume everything. Suggestion: Increase your consumption rate by 50 % of the raise and put the other 50 % into your savings rate.
How to Start Investing: When to start investing money
As early as possible! You will be thankful in the future: The longer your money can work for you, the stronger is the compound interest effect. The diagram shows the exponential growth for an investment in stocks with an average return of 8 % yearly (before tax):
Taking this example to you a pratical level: The table below shows you the performance of your money for every decade. After 10 years your investment has already doubled without doing any work. After 30 years it has increased by factor 10 and after 50 years it has increased by factor 46. Let’s say you’re 20 years old and invest 10.000 € for your retirement. When you hold the security until you’re 70 years you made almost half a million € —> not that bad for a pension 😉
Now of course this is a bit extreme because you’re maybe not 20 anymore or don’t have 10.000 € in cash, but it gives you an understanding for what is possible.
How to Start Investing: Where to invest money
You can invest your money in tons of different asset classes that have different characteristics but mainly vary in risk preference. Furthermore, we currently experience a low interest period. Central banks provide cheap money to the local banks and buy bonds to support economy growth. This is beneficial to debitors but cause massive disadvantage to savers who receive almost zero interest for low risk assets like savings accounts, money market and bonds. In these periods it makes more sense to invest long-term in real estate or stocks because they profit from low interest rates.
Savings Account
- Overnight Deposit or Term Deposit at your bank
- Very low interest rate (<0,5 %)
- No risk
Money Market
- Short term debt securities (e.g. short term government bonds)
- Low interest rate (0-2 %)
- very low risk
Bond Market
- Debt capital with fixed duration and fixed interest issued by governments and companies
- Low to medium interest rates (0-3 %)
- Risk can vary from very low to medium
Real Estate Market
- Investment in properties (houses, appartments, lands)
- Medium to high interest rates (~5 %)
- Risk can very from very low to medium
Stock Market
- Shares of a company (equity capital) with profit participation
- High interest rates (~8 %)
- Risk can very from medium to high
Alternative Assets
The following assets are usually not appropriate for a long-term investment strategy, but rather for spectulative purpose:
Cryptocurrency Market
- Utility or Security Token issued by a blockchain company
- Interest rates can go beyond 1.000 %, but only in short term
- Very high risk (speculative asset)
Commodity Market:
- Commodity certificates e.g. gas, oil, energy, water, coffee, textiles
- There’s usually no long term growth
- Medium to high risk
Gold Market
- Certificates for precious metal e.g. gold, silver
- There’s usually no long term growth
- Low to medium risk
A detailed explanation of the different asset classes can be found in the article ,,>>what assets to invest into<<
How to invest money
How to invest money mainly depends on the asset you want to buy. In most cases you need a broker who enables access to an exchange. The exchange is a marketplace that brings supply and demand for financial instruments together. After registering for your securities account you can transfer money to your balance and start trading. Most broker offer free online accounts so that trading can be done easily from your computer. However, you pay a small fee for your orders, e.g. when you buy or sell an asset.
Here you find an overview of the best broker.
Another way how to invest money is by a robo-advisor. In this case you also offer a securities account at a broker but you don’t decide which assets to buy. Instead you follow the strategy of the robo-advisor who will create a portfolio of investment funds for you. This method includes slightly higher fees but can be interesting for our super lazy investors.
Here you find an overview of the best robo-advisor.
Investment Strategy: Risks vs. Return vs. Liquidity
To decide which investment strategy fits best to your preferences you need to understand the investment triangle of risk, return and liquidty.
This financial law shows that high return,
high safety and high liquidity (=availability of your money) cannot be achieved at the same time. If you want a higher return you need to give up some safety and/or some liquidity. If you want high security or high liquidity you need to give up a high return.
In other words: You can achieve high returns when you’re willing to invest longterm and accept a certain value flactuation of your investment. Also, diversification of different assets allow you to reduce the risk mathematically without losing return.
The best balance between risk, return and liqudity is offered by stocks.
Find out how to invest in a diversified stock portfolio to achieve high return and mitigate risks.
