Investing is an exciting -- but daunting -- concept. How do you know if you're ready to take the plunge into the stock market and start to make your money work for you?
Not to worry! The Motley Fool's own Dan Kline is here to answer all your burning questions about how, when, and where you should be investing. And here at the Fool, we understand that not every investor is alike. Dan cuts through the jargon, defines key concepts, and gives you a list of variables to consider so you can enter the market armed with the right information to make you smarter, richer, and happier.
A full transcript follows the video.
Narrator: Hey! I'm Motley Fool contributor Dan Kline and on this episode of FAQ we're talking about when you should start investing and how starting as soon as you can will help with all your long-term financial goals.
In most cases, we tell beginners that the best time to start investing is NOW, but there is one big caveat. You should pay off any high-interest debt before investing. What counts as high interest? Anything over the 9-10% annualized return you can expect over the long-term from investing. Those returns, of course, aren't guaranteed, but that's historically what has happened when you factor in stock prices rising and dividends.
So, before you start investing, pay off your credit cards, personal loans, and payday loans if they're over that threshold. After that, it's time to figure out how much you can invest.
To decide how you should invest, you need to do one major thing first -- and that's make a budget. Examine how much money you have coming in and how much you have going out. Break down your mandatory expenses like rent or mortgage, car payments, food, utilities, and any other pay-every-month bills and then look at your discretionary spending -- things like entertainment and eating out.
Ideally, you will have a surplus and that's money you can invest. Of course, that does not mean you should only invest that money. You may want to tweak your budget and make spending cuts in order to be able to put more into your investments. You may also consider taking on a second gig or a side hustle to further your long-term financial goals.
Once all of that's settled, it's time to start investing and that can be scary. The stock market isn't something most people think about on a day-to-day basis and much of the news about it focuses on the extremes.
It's important to remember what stocks are. They're shares of individual companies. You may not be able to read a balance sheet and you probably don't read quarterly reports but you do have brands and companies that mean something to you. Start there.
We're not going to fully go into how to start investing -- that's a broader topic for a different episode -- but when the time comes remember the old adage that you should buy what you know. I, for example, own shares in Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) -- two companies that are part of my everyday life that make products I love.
New investors should also be aware of index funds. An index fund is collection of stocks designed to match a market index -- like the S&P 500. This lets you invest your money broadly with performance not dependent upon one company but the market as a whole. This is a great way to get started without having to become a stock market expert.
However you start, the most important thing is that you do start and that's because of the magic of compounding. Okay, it's not really magic but compounding can work wonders if you start early.
What is compounding? It's the concept that your money grows over time because you're not just experiencing growth on your original investment, but on any gains it has made.
Imagine if you buy shares in a company that sells robot-produced pizza and coffee, well call it Robo Joe & Pizza. If that company grows by the market's historical average of around 10%, a year one investment will be worth $1,100 at the end of the year. A year later, assuming the same 10% growth, your investment will be worth $1,210.
It starts slow but after 10 years you'll have $2,594 and in 15 you'll be at $4,177. Of course, the stock market isn't that predictable. Your portfolio won't increase by 10% exactly each year but over time, but this is generally how compounding works.
Invest early and your money will go to work for you. Over time, relatively small gains can produce a big balance in your retirement account. Using a simple compounding interest formula that assumes a 10% gain, $1,000 invested at 20 would be worth $72,890.48 at 65. Shorten that time table from 45 years to 20 and it's only worth $6,727.50.
That's why investing isn't something you should put off. It's a lot easier to meet your retirement goals if you start early. You don't have to be a genius or even pick individual stocks. You can buy index funds -- and like one of those rotisserie cookers -- set it and forget it. Of course, while a chicken might take a few hours to cook and your portfolio will need decades, but it's still the same principle. Start early and you won't have to work as hard later.