From Factory Floors to Financial Freedom
In a recent talk with my nephew, a hardworking factory employee, I showed him that by saving just $500 a month and wisely investing it, he could potentially amass a whopping $1 million by the time he reaches 50. Just like so many people in similar circumstances, he thought becoming a millionaire was a dream reserved for the fortunate few. In this article, I'll explain the basics of investing in stocks that can turn the dreams of everyday people into realities.
Getting Started: Understanding Shares and Stocks with a Lemonade Stand
Shares:
Shares are like individual ownership pieces of a company.
“I own 10 shares of 100 available shares, I own 10% of a company!”
Stock:
Stock is all the shares of a company added together.
“Did you see what happened to Microsofts stock the other day?”
The Lemonade Stand:
Imagine a young entrepreneur named Lilly, who starts a lemonade stand in her neighborhood. She has countless customers and has the idea to buy some supplies to build more stands and put them around the neighborhood and hire her friends to sell lemonade at the stands, but supplies are expensive, and she doesn’t have that kind of money. So Lilly decides to sell some stock of her lemonade stand business. She decides her lemonade stand is worth $1,000 and decides to offer 10 shares to her friends and family (the basic parts of how a company’s stock is divided). This means each share (each part of the company) is worth $100 because $100 for a single share x 10 total shares in the business = $1,000 of total stock.
Lilly wants to keep the majority of the shares, so she can keep majority ownership, so she keeps 6 of the 10 shares, and offers 4 for sale hoping to raise $400 because 4 shares (parts of the company) x $100 (price of a share) = $400. Her uncle buys all 4 shares, and she receives $400 from him, and he receives a portion of the company – and a portion of its potential profits and also the potential loss in value of the business.
If Lily's lemonade stand becomes more popular and starts making more money, the value of Lily's Lemonade Stand Stock goes up. If fewer people want to buy Lily's lemonade or if there's a new lemonade stand in town that's really popular, the value of Lily's Lemonade Stand Stock may go down. This is why investing, even in a lemonade stand, can be risky.
Though there are risks, stocks have consistently demonstrated their potential to generate wealth. Over time, investing in stocks has been a proven strategy to grow one's financial portfolio. It's a partial ownership strategy that allows individuals to have a stake in various businesses, and while there are risks involved, the potential rewards have historically made it a sound choice for wealth-building.
The Power of Putting Your Money to Work
Think of your money, each dollar, as a potential employee able to do work for you. Let’s look at three potential places everyday people are likely to put their money, and where the money (your employees) are harder at work for you. Let’s look at three places typical Americans put their money, and how these choices impact their future.
A Savings Account: According to Gallup, only 29% of households with annual incomes under $40,000 have any money invested in the stock market. This means 71% of these households are likely holding money at their bank or credit union. 71% of these households are not putting their dollars (their little employees) to work for them. The national average interest rate on savings accounts stands at 0.43% – ill show you what this means for your money in a chart below.
Under a mattress: A survey of more than 1,800 people from American Express found that 43% of Americans keep their savings in cash, with 53% of those people hiding money in a secret location at home - like under a mattress. Money under a mattress, or stashed away anywhere in the home, is money that is sound asleep. These snoozing workers are earning 0.0% interest.
Investment Accounts: Many Americans put their money in investment accounts operated by a brokerage, which is a type of company that connects buyers and sellers of stocks, bonds, mutual funds, and other stuff. These accounts offer a wide range of investment options, giving everyday people access to the stock market - our focus here. Rates of return, how hard your money is working for you, can vary greatly depending on how you choose to invest. Here you won’t find Lilly’s Lemonade Stand, but you will find companies like Apple, Microsoft, and thousands of other publicly listed companies. The advice in this article as we cover just the basics will be to buy the “S&P 500” (a collection of 500 American companies chosen by professionals) which over the last 20 years returned on average 9.75%.
Of these three pretty basic, but also pretty common places average, every day Americans choose to put their money we learned that saving accounts earn about 0.43%, storing money under a mattress earns 0%, and investing in the S&P 500 earned about 9.75% over the past twenty years. The chart below illustrates how much $400 left alone for 20 years just sitting there in either of these places would grow according to the rate of return.
Some new terms as we continue…
Index:
A big list of a bunch of different companies shares selected by experts. Sort of like someone telling you about their special pen collection, “This collection contains 2 red pens, 3 blue pens, 1 green pen, etc.” or “This index contains 3% Monsanto, 4% Microsoft, 2% Exxon, etc.”
“The S&P 500 index is like that persons very special pen collection representing a diverse range of the best companies in America.”
Index Fund:
The actual pot of money representing the index or special collection of stocks. When you invest in a specific index fund like the S&P 500, you’re trusting your money with professionals to buy according to the index (the list of stuff) that the index fund is replicating.
“ I put my money in an index fund that follows the S&P 500 so I can own a piece of lots of different companies!”
Your Best Friend: The S&P 500 - The Billionaire’s Tool to Beat Wall Street
The S&P 500, often referred to as simply "the S&P," is the doorway into understanding the heart and soul of the U.S. stock market. If you're new to investing or just dipping your toes into the world of finance, this is where you should begin.
Think of the S&P 500 as a collection of the 500 most prominent and influential companies in the United States. These aren't just any companies; they're the giants, the trendsetters, the household names. Apple, Amazon, Microsoft - they're all in there. When people say "the market is up" or "the market is down," they're usually talking about the S&P 500.
The S&P 500 isn’t just for new investors. In fact, one of the world's most legendary investors, Warren Buffett, famously relied on it to win a $1 million bet against an entire investment firm (Protégé Partners) that uses complex mathematical models and algorithms instead of a simple “buy and hold” approach – otherwise known as “passive investing.” Buffett's belief was that an S&P 500 index fund would outperform a hands-on, portfolio selected and managed by experts over 10 years – in part because these money managers charge expensive fees. The bet pit two basic investing philosophies against each other, and the one available to you, the everyday person, beat the experts on Wall Street!
Warren Buffett won that bet, by investing in the S&P 500 and doing nothing more. Which means you don’t have to do anything more than that to invest well. By taking this approach, investors can feel confident they are investing in some of the best companies America has to offer. It means you get to have a small ownership in these companies, and the best part is you don’t have to do any work. This is a “set it and forget it” style of investing. Over the last 15 years the S&P 500 has outperformed 92% of other funds.
Simplicity can often beat complexity. The S&P 500, a representation of the broader market, has consistently delivered solid returns over the long term. While there's a place for complex strategies, don't underestimate the power of a straightforward investment in this index. It's a lesson that even the best and brightest on Wall Street had to learn the hard way.
The Math Paving the Path Towards Financial Freedom
Here’s the math equation to calculate the “future value” of investments:
Future Value (FV) = Present Value (PV) + Monthly Investment x [(1 + Monthly Interest Rate)^(Total Months) - 1] / Monthly Interest Rate
We can use this formula to show the advantage of starting young as an investor, and what it means for investors later in life as they delay the choice to put their money to work. In the chart below there are three scenarios for someone at different ages making the commitment to invest, in this case in the S&P 500 and its 9.75% average return:
At 18 years-old starting with $0 and investing $500 per month until age 50, resulting in about $1.3 million.
At 30 years-old starting with $140,000 and investing $500 per month until age 50, resulting in about $1.3 million.
At 40 years-old starting with $500,000 and investing $500 per month until age 50, resulting in about $1.3 million.
How many 30 year-olds have $140,000 lying around to when they decide to start investing? And if you wait 10 more years until you’re 40 to start investing, you’d need to start with $500,000 to get to the same future value as your 18 year-old self if you started investing then.
If you want to start investing, start now, and here’s how:
Set Your Financial Goals:
Define your short-term and long-term financial objectives, such as buying a home, funding your child's education, or retiring comfortably. This will impact how much risk you should be taking with your money. Generally decrease your risk and exposure to the market as you get closer to when you need to pull it out of the market. The Securities and Exchange Commision has a great online calculator that can help you:
Create Your Budget:
Assess your current financial situation and create a budget to determine how much you can comfortably invest each month.
Build an Emergency Fund:
Before investing, ensure you have an emergency fund with at least three to six months' worth of living expenses. This is in case you lose your job and it takes a while to get a new one, and for many other challenges life throws at you.
Educate Yourself:
This article is but a drop in a very large bucket. There is much more to learn to protect what you have.
Choose an Investment Account:
This is basically determined by your financial goals. If you’re saving for retirement, you’re better off with a 401(k) or IRA, which allows you to invest in pre-taxed money, but you get taxed at a lower rate while in retirement. If you’re saving for a house or something else, then don’t worry about a 401(k) or IRA. Chances are though you should have a retirement account and a general investment account, but it’s up to you to decide how much to put in each based on your goals.
Select a Brokerage Company:
Sign up with a reputable brokerage company. I like Fidelity, but there are tons to choose from. You should compare their features, fees - they charge a small amount for most funds, and available investment options to make an informed choice. They’re generally all the same as far as a typical investor is concerned. Fidelitys S&P 500 fund is “(FXAIX)”, and their expense ratio (their fee) of 0.015% is pretty good. It means a $10,000 investment would have a fee of $1.50.
Some brokers have a minimum amount needed to invest, but many do not.
Complete Account Setup:
Provide the required personal and financial information to open your investment account. Verify your identity as needed.
Fund Your Account:
Transfer money into your brokerage account. You can start with a small amount and gradually increase your investments over time. This is generally the best advice and is called “dollar cost averaging.” For example investing $500 every month.
Choose Your Investments:
Based on your goals and risk tolerance, select specific investments. For beginners, low-cost index funds like the S&P 500 can be a good starting point.
Start Investing:
Execute your first investment order through your brokerage platform. And set up automatic reoccurring investments if you can.
Monitor and Adjust:
Regularly review, perhaps every 3 months, your portfolio's performance and make adjustments as needed. Though if you’re just investing in the S&P 500, there’s nothing to do.
Stay Patient and Disciplined:
Remember that investing is a long-term game. Stay patient during market fluctuations and avoid making impulsive decisions based on short-term events. Do not try to catch a “falling knife.”
Celebrate Milestones:
Celebrate your investment milestones and achievements, whether it's reaching a savings goal or seeing your portfolio grow over time