Why Invest in the First Place?
Article Last Updated: 28 January 2021
Investing is about building wealth. It's about having financial assets that increase in value over time.
While buying shares remains one of the most popular ways to grow your money, beginners often ask: why should I invest in the stock market and not something else?
It's a good question to ask and one that we will explore the answer to here, letting you draw your own conclusions.
We want to begin by pointing out that Australian interest rates are at historical lows and will likely stay low for some time. This means money left in savings products won't grow much. In fact, recent Reserve Bank of Australia data reveals a 3-year term deposit of $10,000 attracts an interest rate of just 0.90%.
You'll likely get a far better return by investing in the share market — if you're willing to invest for the long term. Before jumping into it, it's vital to prepare yourself so you can deal with the highs and lows of being an investor.
Our philosophy for investing
Investment success begins with the right mindset. Here is a summary of The Motley Fool investment philosophy:
- There's no magic formula. Wealth creation is about learning from others, careful stock selection and education. Get-rich-quick schemes won't work.
- The market goes up...and down. Although the stock market fluctuates, what's important is that long-term returns trend upwards.
- Appreciate the odds. To paraphrase US fund manager Peter Lynch, even if you're "good" at investing, you'll still get it right just 6 out of 10 times.
- Boost odds with diversification. If we're wrong 4 out of 10 times, then owning enough stocks puts the odds back in our favour.
- Invest for the long term. You need to give the market time to agree with your judgment or valuation of a company. You also need to allow time for the compounding effect of constantly reinvesting your capital growth or dividends to reap rewards.
- Be prepared emotionally. It's not easy but essential to avoid panicking when the market crashes.
Investing is more affordable than you may think
A great reason to invest in shares is that you can get started with as little as $500. You'll need to factor in brokerage costs, which can vary from $5 to $30 or even higher, depending on whether you're trading online or over the phone, how often you trade, and the amount you wish to invest.
Exchange-traded funds (ETFs) are often popular with beginners, too, because they offer a low cost and offer a simplified approach to invest in a collection of shares.
The market isn't out to get you
Despite the advantages of share investing, some potential investors shy away because they believe you have to be a stock genius to succeed.
While you'll need to understand stock market basics, you don't have to outsmart the market or time every trade perfectly to protect your capital and compound your returns. In other words, investing isn't hard to do nor a time-drain.
When you look at a chart of stock market returns, two things stand out. Firstly, prices fluctuate in the short term. Secondly, market returns tend to grow over time. Putting these two things together means if you have a diversified portfolio and a long investment horizon, then you've got a good chance of seeing investment growth even if there is short-term volatility.
So the market might go up and down, but it certainly isn't out to get you!
Risks to bear in mind when investing
Of course, there's no denying that one of your share investments could also fall in value. That's why it's important to understand the risks involved before investing.
Economic changes that negatively affect the whole market are known as market risks. Events that challenge a particular sector — like the devastating blows to the travel industry in the wake of COVID-19 — are sector risks. Currency movements can also impact returns if you invest in an overseas company or an Australian company with significant operations or investments abroad.
These risks highlight the need to diversify your portfolio to limit the impact of poor performance from a single investment.
Determining risk preferences
Risk preferences play a key role in making the right investment choices. Shares are growth investments, which means they offer greater potential returns — but they also involve a higher chance of losing money.
Determining how much risk to take requires you to be honest about your ability to cope if your investment falls in value. How much can you stand to lose without feeling overwhelmed? The answer to this is influenced by factors like how old you are, how easily you can recover from losing money, and what your financial goals are.
If you are investing to meet long term financial goals, then shares are a fantastic option because a lengthy time horizon allows you to ride out short-term fluctuations. However, if you can't keep money invested for a lengthy period or you're aiming to achieve short-term goals, then lower-risk options like savings or term deposits would be more suitable.
Factors to consider prior to investing
Apart from assessing your attitude to risk, it's helpful to also do the following before taking the first step in investing.
- Draw your financial roadmap. It's hard to pick investments that match your risk tolerance and time horizon if you don't know what your financial goals are.
- Pay off high-interest debt. Compounding works both ways. High-interest debt like credit card balances can snowball over time and offset any investment gains.
- Have an emergency fund. To make sure you can invest long term, you need to set money aside to cope with short term emergencies.
- Consider your investment mix. It's a good idea to diversify rather than invest heavily in any one individual stock — including your employer's stock.
- Take advantage of 'free money' from your employer. Some companies incentivise employees by offering discounted shares. Don't let these opportunities pass by if your company is doing well.
- Look out for scams. Be informed of the latest investment scams and check the legitimacy of any investment or advice.
When should I expect to see a return?
Shareholders receive returns in the form of dividends or capital growth.
If you're looking for a regular return, then income shares are worth considering because they tend to (but not always!) pay regular dividends. Blue-chip companies are often cash-rich, so many blue-chip shares are income shares and pay annual dividends.
If you're looking for capital growth — that is, an increase in the value of your shareholding — then how soon you can expect returns depends on company-specific and market factors. However, you should be prepared for an investment timeframe of 5 years or more.
History of return
According to the 2020 Vanguard Index Chart, $10,000 invested in the Australian share market 30 years ago yields a return of 8.9%, outperforming returns for property, bonds, and cash investments.
The same amount invested in shares 10 years ago produces a return of 7.8%, while a 5-year investment returns 6.2%.
Get started with investing
In this investing 101, we have covered why share buying is an effective path to wealth. Hopefully, this inspires you to kickstart your investor journey soon.
You may be wondering: Why should I invest sooner rather than later?
The answer is that the earlier you start, the better you'll do because you're allowing more time for the compounding effect to drive up your investment value. In this way, share investing can put you in a great position to grow your money and experience long-term wealth.
Learn More About Investing with The Motley Fool
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