It’s been a while since I wrote a post on finance and money but it is just as an integral part of being able to live to your full potential as any supplement you can take or mindset you can cultivate.
While there is no need to be filthy rich, being smart with your money can certainly set you up for any sort of life you want to live and give you that all important freedom. Whereas being wasteful and uninformed with money and personal finances will inevitably lead to the shackles being placed on firmly for the rest of your days.
Why you should start investing your money
Jumping into the world of investment is definitely viewed as a massive leap of faith. From my own experiences and the experiences of others, I know that it is like staring into the dark abyss. It can feel like throwing your money down a deep, dark well hoping for something bigger and better to rise back to the surface.
‘Not for me’, you might say. When I spend my money on a meal deal, I know exactly what meal deal I am going to get. I’m unlikely to get extra bacon in my sandwich but I’m unlikely to get less than expected either.
Investment at first glance isn’t like that. It’s risky, it’s high stress and it’s best left for people with fancy suits.
That’s not the case though and here’s why.
Ah, yes. That word we often hear on the news or part of a political campaign. It’s a common feature of any modern society and economy and rather than dismiss it, it’s actually important to understand what it is and how it affects you.
Inflation refers to the phenomenon of prices rising over time for the same things. Remember when Freddos cost 10p? You can thank inflation for their crazily high prices nowadays.
This may seem like a trivial rise but what it actually shows is that your spending power is less than what it used to be. That 10p coin that could buy you a Freddo five years ago can’t even buy you half a Freddo. The Freddo hasn’t changed. The 10p coined hasn’t changed. The only thing that has changed is inflation and as a result, your spending power.
Taking this idea to the bigger leagues, this graph from Monevator shows the impact of inflation over 25 years. Say you do a big heist on a bank and manage to obtain and store away £10,000 for a later date. If inflation was 2% a year, which is actually quite modest, and you came back 25 years later to collect your money from the safe, here’s what would happen:
Your £10,000 would still be there, fantastic! However, due to inflation, that £10,000 from year 1 only has the buying power of just over £6000 in year 25.
A bit like the Freddo scenario: with the same amount of money you can no longer buy the same amount of things. You haven’t spent a penny of the £10,000, yet you have become almost 40% poorer in real terms. That’s no fun.
Maybe you have yourself a decent cash savings account. The account pays 2% interest each year on whatever savings you have in there. So all you need to do is save the money, and you will get 2% added on to your total each year. That’s not bad.
The blue bars in the graph above show your £10,000 growing at 2% each year in a cash savings account. This looks really promising until you realise that there are still those red inflation bars that we saw earlier working in the opposite direction to our savings. Like before, they are decreasing our spending power by 2% each year. So what does that mean overall? You guessed it:
The 2% growth on our savings (blue) clashes with the 2% rate of inflation (red) and they end up cancelling each other out.
Our £10,000 has the same spending power over the 25 years (green).
That’s a much better scenario than the Freddo/heist situation we saw before, but we aren’t actually gaining anything from just saving. The money is sort of just sitting around being lazy rather than gaining anything for us.
This is why aimlessly spending is the worst-case scenario, closely followed by locking your cash in a safe, followed by having your money in a cash savings account. The best and only case scenario where we are gaining money and spending power in the future? Investing.
If that is the scenario you desire, then it is time to start seeing investing as less of an unknown enemy and more of someone you should probably get to know a little better. Thankfully, the meeting and greeting stage doesn’t have to be too complicated.
Where to start looking to invest your money
There are all sorts of ways you can invest your money. You can trade daily on the markets, buy up crypto, get your foot into the property market. While all of these have big potential upside, they are often far more stress, effort than they are worth as well as being extremely risky if it all goes wrong.
If you are a first-time investor, I wouldn’t even look at these options.
On the other hand, if you want to put your savings somewhere where they will beat inflation, the gains won’t be astronomical but they will be steady, you don’t need to learn all sorts of complicated graphs and perhaps most crucially of all, you don’t have to constantly manage it, then there is a place to invest for you. Time is precious people and while tinkering with your various stocks might fuel the ego and give you something to try and impress your mates with, you are far better off putting your money in the right place, putting the kettle on and letting it do its own thing.
So where is the magical place to invest money? Well, it is known as index funding.
It’s basic, it’s boring, it’s unsexy and it’s perfect.
Investing in an index fund is like owning a tiny part of each company in that index for a very low cost.
Take the FTSE 100 for example which is the index of the top 100 companies listed on the London Stock Exchange. If you were to invest in a tracker for the FTSE 100 it would mean that with whatever you invest, you own a tiny fraction of all of 100 companies. Therefore however the stock market does, is how your investment does (usually minus a tracking fee of <1%).
Whichever index fund you do decide to invest in, you will be backing that index to grow over time faster than if you just held the same amount of money as cash or in a cash savings account. This tends to be the case. Across all of the companies, on average, there is almost always a steady growth rate.
Index fund investing is a long-term game. That means you don’t need to check how the stock exchange is getting on each morning. You shouldn’t worry if the market takes a downturn nor should you go on a spending spree when the going is good. The longer you leave your investments to go through the cycles that they will inevitably go through, the more time you give the maths and investment to do their magic and average out for a good return for you. Index Fund Investing is a form of passive income and investment.
If you’re young, now is the best time to get on index funds since you have the rest of your life ahead of you for your money to consistently compound and give you great returns.
As they say, the best time to plant a tree was 20 years ago. The second best time is right now. So if you aren’t as young as you would have like to have been when deciding that investing was for you, fear not! Getting involved with index funding is still a great option as it still beats the inflation, savings and all of that other stuff we talked about before. It’s cheap, it’s simple and it manages itself – ideal!
The investment strategy that I use may not be for you, so be sure to do your research first (extra resources at the bottom of the page), but it does follow all of the principles that we have talked about above.
What I and many other people do is invest in a Vanguard Life Strategy fund.
In its most basic form, Life Strategy funds allow you to put money into a portfolio which invests a bit of your money into a spread of big global companies. Rather than just in a domestic fund (e.g. FTSE 100), my money is currently invested in tiny fragments of countries all over the world. This is to mitigate risk (a big crash in the UK, for example, would affect some but not all of my investments). As covered above, the spread of investments means that the returns are often not spectacular but are very consistent and grow massively as time goes on.
I set my specific fund to an ‘accumulator fund’. This means that any returns I make are reinvested into the fund, rather than collecting anything that I’ve earned. Again, this leads to the magic of compounding over time. My money will eventually start to make its own money from the interest until it is making enough to live off without any extra investment. At this point, I will be able to live off the interest for the rest of my days.
Admittedly this scenario is a long way off but will get faster the more my save(and invest) to spend ratio increases. Google ‘Financial Independence’ and you will find thousands of people who have managed to achieve this through index funds, compound interest and utilising things like the 4% rule.
I hope that this is just the start of your investing journey. You will find some excellent links dotted throughout this post, but here are some others from guys that go deeper and more detailed than I as well as being much more qualified than I am to talk about this sort of stuff.
I hope you take advantage of their resources and expertise as much as I have.
- Five Reasons Why You’ll Love Index Investing
- The simplest, most effective investment decision you will ever make
- Why I wish they’d taught me about compound interest at school
- A Strategy for Life: Using Vanguard LifeStrategy Funds to simplify investment
- Compare the UK’s cheapest online brokers
MR MONEY MUSTACHE
- Getting Rich: from Zero to Hero in One Blog Post
- The Shockingly Simple Math Behind Early Retirement
- The 4% Rule: The Easy Answer to ‘How Much Do I need for Retirement?’