The Motley Fool is dedicated to the proposition that an individual can, if they invest properly, beat the market. So we're here to give those investors a leg up on the process with our best Foolish advice. But to make use of that advice, you have to be in the market. And while our tips generally start from the premise that our listeners will be, plenty of folks aren't.
We understand. Investing is complicated. It puts your hard-earned money at risk. And the closer one looks, the more there seems to be to learn.
If you're one of the many who want to begin, this Rule Breaker Investing podcast is for you. David Gardner has gathered a talented trio of Fools -- Jason Moser, Matt Trogdon, and David Kretzmann -- to gently guide us through the basics of how to become an investor. In this segment, they lay out five investing terms that you may or may not totally have a handle on, and more importantly, discuss not just the definitions, but why they matter.
A full transcript follows the video.
This video was recorded on Oct. 3, 2018.
David Gardner: I love how we have a mix of a certified financial planner. Congratulations, Matt Trogdon, with your CFP! Jason, who's taking about acting as a business owner. And David who, with Jason, has taught a lot of kids, because through Fool's School, our Fool's School initiative, we've welcomed kids into Fool HQ and we sometimes go out into the Greater Washington, D.C. area, if invited, and teach kids.
So you guys have a lot of experience talking to other people. I want you each to think briefly about a single term that you would want to make sure somebody knows what that word is, what it means, before they get started investing.
David Kretzmann: I'll go with "equities." That's a term you hear thrown out a lot. Equity or equities. That's really just a fancy [or I might even say snobby] way to say "stocks." It's the same thing. Those terms are interchangeable. It can be a fancy term that's thrown out there in the media, but when you hear equities, that's the same thing as a stock.
Gardner: And I know for you and me, David, both of us love stocks. We're not the only ones at the table, but a little later you're going to specifically be thinking about people who want to start investing with a "stock," and you're going to present a little bit more on that.
Because you guys all know that there are multiple ways to get started investing what you're investing in, and I think Matt, you'll be speaking to funds a little bit later and, Jason, you'll be speaking to getting kids going. So yes, appreciate that. Coming from a fellow stock guy to another stock guy, you've just given one of the key terms that confuses people and makes a lot of people feel like they don't understand enough to really know what they're doing. But equities -- it's pretty easy to look up in the dictionary, and we might even use it sometimes in this podcast, but it's synonymous with stocks.
Kretzmann: Yes. It's just good to know. It's a simple term, but you've got to start with the basics.
Jason Moser: I think I'll just jump in there and say "returns." It's probably pretty easy to think that you're just telling me to just go back from where I started, and that is not the case, obviously. When we talk about returns, we're talking about what is happening to your money. It's either growing or it's diminishing. Ideally we like to talk about the growing part but over any given period of time, hopefully your money is increasing in value [your investment is increasing in value], and that would be your returns.
One of the more fun parts of our Fool's School class is we get to go over a 10-year time period where we talk about the market's returns and how that would affect you if you were invested in the market for that 10-year stretch and we reveal the returns for the stock market each year. I think we also compare it to a basic savings account and the returns that you would get with that. But the returns -- that's the money that you're making.
Gardner: Yes. And Jason, rule of thumb, here. What is typically the stat that we quote as an annual return for the stock market measured over long periods of time?
Moser: Typically we quote anywhere between 6-8%. I've heard all three, so let's just go with 7%. Let's cut it down the middle.
Gardner: All right. I've often said 10% but that's not factoring in things like inflation. So if you take out 2% inflation money, since it tends to get printed more and more over time, it tends to be devalued when we print a lot of it. That's what creates inflation. And so if you're looking at historic returns for the market of 8-10%, but you deduct 2% every year for that, the real return is somewhere closer to that 6-7%. Good. Matt, what term comes to mind for you?
Matt Trogdon: I'm going to go with "time horizon." I think it's such an important term for investors. So much is dependent on what you consider your time horizon to be. Going back to our example of someone at the ripe, young age of 36, he or she would be investing, in theory, with a time horizon of maybe 30 years or more.
Gardner: Let's hope 50 or more. Matt, you look really fit to me!
Trogdon: Well, thanks David!
Gardner: I've got you pegged for probably 60 or more, if you like.
Trogdon: Yes, you've got to keep eating the vegetables.
Gardner: Did we just double your time horizon in less than 30 seconds?
Trogdon: Yeah, imagine that!
Gardner: That's profound.
Kretzmann: Well done!
Trogdon: Imagine that. But if you're thinking about investing over a 30-year or 50-year time horizon, then you should be making different decisions than if you're just investing over a three-year to five-year time horizon. As we all know, the stock market can be extremely volatile over a one-year period or even a three-year or a five-year period, but historically the trend is pretty steady in the upwards-to-the-right direction if you look over a 10-year, 20-year, or a 30-year period. So just thinking about what your time horizon is before you start investing I think will help you make decisions down the road.
Kretzmann: And something else to add to that is that the longer your holding period or the longer your time horizon, the greater the odds that you will make money over the longer term because looking at the data of the S&P 500 going back to 1871, there's actually never been any 20-year stretch where if you bought and held S&P 500 for 20 years, where you would actually lose money. You would gain money over every 20-year period. That goes through World War I, the Great Depression, World War II, the Great Recession. So lengthening that window where you can buy and hold stocks dramatically increases your odds of coming out ahead as an investor.
Gardner: And maybe I'll make that my term -- the "S&P 500." A lot of people who regularly listen to this podcast know that as the Standard & Poor's 500, but I'm sure we have some new listeners this week, and I want to make sure that you know that the S&P 500 is 500 of the largest companies in America. It's chosen by Standard & Poor's, which is a longtime publishing company that got its brand on this group of stocks [the S&P 500].
It's companies like Apple, and Home Depot, and a lot of the companies you'd expect to be there, but we use the S&P 500 as a proxy for the overall market's return. There are certainly a lot more stocks than just those 500, but when you take those 500, that's a pretty good way of estimating how they do in a given year. We say that's "how the stock market does."
Now you'll also hear the Dow Jones Industrial Average quoted on the nightly news and online sites like ours, and that's just 30 companies. It's a much smaller group, and it's a longer-standing traditional index. I don't think it's as effective a measure because it's just 30 companies and there's some historicity that makes it a little bit funky; but, it's so popular and so talked about that I did want to mention it here.
But the S&P 500 for us, here, at Fool HQ is a group of companies and a phrase that we just take for granted. I would want to make sure anybody who's thinking of getting started investing this week knows that you can buy an S&P 500 "fund," which we might talk about later. Or a lot of the companies that you might buy. Like, Matt, when you bought J.P. Morgan back in the day as your first stock, I'm pretty sure that was in the S&P 500.
Trogdon: Absolutely. One term that we haven't mentioned but that I think is kind of beneath the surface of all of our other terms is "compounding." I think the most powerful idea in investing [and certainly one of the more powerful things I ever learned] was how money compounds and money grows.
Compounding can work for you on the upside in the stock market or it can work for you on the downside with credit card debt. But if you think about investing over a long period of time and getting a sustained return year after year, that money grows exponentially and not linearly and that's something I wish more people knew.
Gardner: So that 8-10% -- let's just call it 9%. That first year, if you have an average year, your money just went up 9%. And as Jason said earlier, good news. You didn't have to do anything. That's one of the reasons I love investing. We can all be lazy bums and just make good choices and your money, as Jason said earlier, works for you. So you're up 9%. That next year you're up 9% more. Well, good news! You'd already made 9%, so if you had $1,000 you were actually at $1,090 and that goes up 9% and all of a sudden that's more than just $90. And 10 and 20 and 30 years later, that just starts being very profound.
Maybe one of the heartbreak truths about people not investing is that they don't understand that, as Matt said. Often they're making the opposite mistake. They're actually paying at high double-digit rates credit card debt and that's compounding against you as well. That's what keeps a lot of people in the cycle of poverty or near poverty. They can't break indebtedness for that same reason.
But again, going back to the positive, here, those of us who've started investing; that's the purpose of the podcast this week, is to get you on that train. I'm glad you mentioned compounding, Matt, because it's so profound. And, again, one of the heartbreak stories of investing is it's not that exciting to make $90 in your first year. It doesn't sound like something that was that big of a deal.
But when you can just play it forward 10 or 25 years later, 9% at that point is really meaningful. Often you're going to be making more in an entire year off 9% [say 25 years from now] than you started with today, and part of what we're trying to do, here, at The Motley Fool, is open people's eyes to recognize that that's how life works and to get on that train.
Moser: One of the biggest mistakes I see with folks who are just getting into investing at an older age is because they have delayed that for so long they feel like they have to make up extra ground, and unfortunately that's not the way it works. We talk about people wanting to get rich quick and if it was that easy, like I said, everybody would be doing it.
So if you are just getting started in investing and you're 35 or 40 years old, make sure you're going in there with the appropriate expectations. Don't think that this is going to be your opportunity just to make up all of this lost ground. It doesn't work that way. You do need to get started, but really time is your buddy, and that's what we teach these kids all the time. That's what we were taught as kids. It is amazing the difference that time makes.
And when you're 15, most people don't really care about investing all that much. Then all of a sudden you're 30 and you realize, "Oh, yeah! I've got that investment account that's been working for me all these years." And that was really my goal in starting my kids with it at five and six. They don't care about this stuff that much. We talk about it every once in a while, but my goal was for them to have a living, breathing example so that when they're adults, they can look back at it and say, "Wow! That's a powerful lesson! I'm going to keep that ball rolling."
Kretzmann: Yes, it's far better to start now with a smaller amount of money rather than wait for some arbitrary number to save and invest down the road. Just start with $50 or $100 today because the sooner you start, you let that magic of compounding work in your favor rather than delaying that down the road.
Something we do with the kids that always gets them jazzed up is a condensed game or experiment to highlight the power of compounding. Imagine you have a 30-day period, a one-month period where you have two options. Option one is you can start with a penny and double its value every day. So day one, one penny. Day two, two pennies. Day three, four pennies and so on for 30 days. Or option two is receiving $100,000 each day for 30 days. So which one do you think would be worth more on day 30?
Gardner: I'm guessing most of us would think that $100,000, because that's so amazing; but, I'm pretty sure the main point of this exercise, David, is the power of compounding.
Kretzmann: Exactly, yes! With option two, with $100,000 a day after 30 days we have $3 million. But with the penny doubling, compounding each day for 30 days, that's worth $5.4 million.
Gardner: It's not even close. Not even close! A total blowout!
Kretzmann: Yes, so let compounding work in your favor. That's a message to hammer home.
Gardner: Not only that, but on day 32. Wait, were you doing 30 days?
Kretzmann: Thirty days.
Moser: This wasn't February, I don't think.
Gardner: So on October 1st, day 31, that $5.4 million goes to $10.8 million and you've still just got that lousy [it doesn't sound that lousy], but lousy $100,000 for the person who made the wrong choice back on day one. So if you play it forward from there, it gets stark.
Kretzmann: Pretty sweet!
Gardner: What a great example!
Trogdon: To make it a little bit darker, how many 55-year-olds do we know that say, "Oh, I want to retire in seven years or I want to retire in 10 years, but I don't think I'm going to be able to. I wish I had another 10 years to save." Now if someone had been able to start saving at 25 instead of 35, or 35 instead of 45; well, there's your 10 years right there. So it's a lot easier to do those 10 years on the front end if you have the money and are able to do it than have to wait to do those 10 years on the back end and potentially have to work longer.