You might have a bit of money saved.
It’s probably not enough for a house, but you reckon I should probably invest this in something.Maybe you’ve heard on the news about Tesla or Netflix or Amazon and how, if you’d invested 10 years ago in Tesla then you’d be a millionaire by now or things like that.
But if you’re new to the game, this whole investment thing can seem like a really complicated black box. Like, how do you even buy a stock? What even is a stock? Do you just go on tesla.com and buy some Tesla, like, how does it work? (chuckles) And if you try and look into this, you get all these acronyms being thrown around like Roth IRAs and 401Ks in America or like ISAs or LISAs in the UK. And on top of that, there is the anxiety that we all have that I know investing is risky and I don’t want to lose all that my money.
So in light of all of that, this is the ultimate guide on how to get started with investing.It is the video I wish I would have had five years ago when I first started investing in stocks and shares. And we’re gonna cover this by thinking about investing in 10 different bite size steps.
So the first one is forgetting about investing completely and just thinking what happens to my money over time by default And if you’ve studied economics, you will know that your money loses its value over time.
Thanks to something called inflation. (bubble pops) Inflation is generally around about the 2%-2.5% mark. And so that means that every year stuff costs about 2% more than it did the year before.
For example, in 1970, in America a cup of coffee cost of 25 cents. But in 2019, that same cup of coffee costs a $1 59. That is inflation in action. And so let’s say you’ve got a thousand pounds in your hand right now. And for the next 10 years, you just stash it under your mattress. And you never look at it again, in 10 years time your thousand pounds is not gonna be worth a thousand pounds anymore because everything would have increased by 2%ish every year.
So the value of your money will have fallen And so if you put your thousand pounds under your mattres for 10 years, you will lose money over time. And this is obviously not good.
Even if you put your money in a savings account, like these days, a savings account will give you like 0.2% interest which means your money goes up by 0.2% every year. But because inflation is up by 2% you’re still losing money over time. And again, this is not good.
Okay, so that begs the question which is key point number two which is how do we stop our money from losing value over time? And the answer is that if we had a hypothetical savings account one that was let’s say an interest rate of 2.5% that would match roughly the rate of inflation. So inflation means everything goes up by 2.5% in terms of price. But our money in our savings account also goes up by 2.5% each year.
Therefore we’re technically not losing money over time. If you’re watching this and you have an issue with the word interest, don’t worry stick to it for now, investment is not the same as interest but we’ll come back to that a bit later. But the point here is that we don’t just want to not lose money which is what happens at our 2.5% rate.
We actually want to make money. And that brings us on to question number three which is, well, how do we actually make money? Now, let’s go back to our hypothetical savings account. If hypothetically, we could have a savings account that was giving us a 10% interest rate this will never happen because that’s just way too high. But hypothetically if it did, that means that every year we’d be making 10% of the value of the money in our savings account.
So for example, if I were to put a hundred pounds in a savings account right now the next year it would be worth 110. And then the year after it will be 121 because it’s 10% of then the 110, and then it would be 130 something. And this would very quickly compound so that in 10 years time, my 100 pounds will have become 259 pounds. And if we adjust for inflation that our money is still worth 206 pounds in 10 years time, this is pretty good. We have more than doubled our money, by just putting it in this hypothetical 10% interest savings account. And it really doesn’t seem like it would do that because 10% feels like a small amount of money.
But if you extrapolate 10% over 10 years you actually double your money, which is pretty awesome. Sadly these hypothetical 10% saving accounts don’t really exist, because it’s just way too high and real life is not that nice.
These days, most savings accounts in the UK and I imagine around the rest of the world as well, offer less than a 1% savings rate, which means you’re actually still losing money over time. But we do have other options to try and get us to this magical Nirvana of like, you know, this 10% saving thingy. And that is where investments come in. So point number four is what is an investment? And the answer is that an investment is something that puts money in your pocket.
For example, let’s say you buy a house for a hundred 1000 pounds and you want to rent it out to people. There are two ways, that’s an investment. There are two ways you’re making money from it.
Firstly, let’s say you’re charging some rent to the people living in your house. Let’s say you’re charging them 830 pounds a month. That becomes 10,000 pounds a year. And so every year you’re making 10,000 pounds in rental income, which is 10% of what you originally paid for the house. That means that in 10 years time you’ll have paid off the a 100,000 pounds that you’ve put in because you’re making 10K a year. And beyond that every year you’re just making 10,000 pounds in pure profit. So that’s pretty good.
But secondly, it’s an investment because the value of the house itself would probably rise over time. In general, there is a trend in most developed countries that house prices tend to rise over the longterm. And so your house will probably be worth more than a hundred thousand pounds in 10 years time. And in fact in the UK, historically in the past, some people have said that house prices have doubled every 10 years.
So maybe your house is worth close to 200,000 pounds. And so you’ve made money off of the rental income but you’ve also made money off of the capital gains which is what we call it when an asset increases in value over time. But the problem is that buying a house is a little bit annoying. You need to have quite a large amount of money for a deposit. You need to get a mortgage. You need to actually have the house. You just sought out the rental management, rent it out to people, all that kind of stuff. If only there were a way of investing without a, having a large amount of money to start with and b, without having to put that much effort into managing the assets as well. And that brings us on to investing in shares. And for me, basically, a hundred percent of my investment portfolio is entirely shares.
I have a tiny percentage in Bitcoin and I own this house but I don’t consider this house an investment. I’ll talk about that in a different video. Therefore number five is what are shares and how do they work? So buying shares probably as close as we’re ever gonna get to this magical savings account that just returns some amount of money each year. And the idea is that when you buy a share, you are buying a part ownership of the company that you’ve got the share in.
For example, let’s say the Apple have a particularly profitable year because lots of people have well iPads as per my recommendations and because Apple are feeling kind, they are choosing to pay out a dividend to their shareholders. So for example they might say that they’re gonna issue a dividend of a million pounds, and that’s gonna be split evenly amongst whoever owns shares in Apple, based on how many shares they own. So for example, if you happen to own 1% of Apple you would get 1% of that dividend that they’ve issued. So 1% of a million pounds, which is 10,000 pounds obviously no one watching this actually owns 1% of Apple, unless Tim Cook, you’re watching, I don’t even know if you own that much because that would make you an extremely rich person because Apple is a very valuable company but that’s basically how the dividend thing works.
A company decides to issue a dividend as a way of returning some of its profit back to the people who have invested in the company. And therefore you make money through dividends.
The second way of making money from shares is sort of like with houses in that you get the capital gains over time. So for example, let’s say you bought 10 shares in Apple in 2010, at the time those shares were selling for $9 each. So yoU Spent $90 on buying 10 shares in Apple.
As of October, 2020, Apple shares sell for $115. So your 10 shares are now worth $1,150 just by the fact that you only paid $90 for them 10 years ago. Okay, so we’ve talked about what a share is and how you make money from them. And at this point you’ve probably got a few questions like how much money you need to get started or how risky is buying shares in a company. And I promise we’re gonna get to that. But point number six is how the hell do you buy a share in the first place? And this is where it can kind of get complicated because it’s not as simple as going on apple.com/buy and just buying a share in Apple. It doesn’t quite work like that. Instead you have to go through, what’s called a broker. And back in the day, a stockbroker was a physical person usually a dude who you would call on the phone and say “Hey, Bob, I want to place an order for some shares in Apple.” And then Bob would types and stuff into his computer or a place like a paper order. And then you would own shares in Apple. Thankfully these days we don’t really have to talk to Bob because there’s loads and loads of online brokers instead. And so you make an account on an online broker and then you can buy shares in a company through that.
A bit annoyingly, every different country has their own different brokers that operate in that country. Because to be an online broker in a country you have to abide by like a zillion different laws. And so in the UK the system is different to the U.S. which is different to Canada and Germany and so on. And the UK, for example, most banks do have their own online brokerage type things. So with most bank accounts you can also open an investment account with them and then invest online. But usually the interface is a bit clunky. It’s a bit old fashioned. And so you’re usually better off going with an online broker. In the UK, the two that I use are Charles Stanley Direct and Vanguard, but before we get ahead of ourselves and make an account on Vanguard or whatever, we need to understand a few more things. And so question number seven is how the hell do I decide which shares to buy? And the easy answer to that is that you actually don’t want to figure out which shares to buy. You do not want to buy individual shares. And I’m gonna tell you a little bit more about that once I’ve had a haircut, so see you shortly.
All right? So new hair, I’ve got my Invisalign braces on. So I’m gonna sound a little bit different but where were we? Oh yeah, we were talking about why it’s not a good idea generally speaking to invest in individual stocks. And I’m gonna do a video about this some other time, but essentially the issue with investing in individual stocks is it’s kind of risky. Like, yes, if you invest in something like Apple, chances are it’s gonna be around 10 years from now. But historically there’ve been quite a few companies that people were like, “Oh my God, this is amazing. This is the thing to invest in.” And then that company went bust. So you’re automatically exposing yourself to more risk if you’re investing in individual stock, also in general, like it’s easy to say, hey, Amazon grew 10X in the last 10 years.
Therefore it’s gonna continue to do the same for the next 10 years. But that’s trying to predict the future. And the past is no real indication of future performance. And so the advice that most people would give for beginners is that you should not invest in individual stocks. You should invest in index funds. And this is what Graham Stephan, one of my favorite YouTubers also says as well. He says, “The index funds are the best, safest, and easiest longterm investment strategy for most people.” Which begs the question point number eight, what the hell is an index fund? So there’s basically two bits to understand here there’s the index bit and the fund bit, Let’s start with the fund bit. And a fund is basically where investors will pool their money, so multiple investors would invest in the same fund. And then that fund would have a fund manager. And the fund manager decides which companiesthe fund is gonna invest in. For example, let’s say I were managing a fund and I called it Gringotts and let’s say a hundred people from my audience decided to invest in my Gringotts fund.
I as the fund manager can say, okay, the Gringotts fund now that we have a hundred people’s money let’s say it’s a 100 million. So everyone’s invested 1 million each I’ve now got a 100 million. I’m gonna put 20% of that in Apple, 10% in Facebook, 10% in Amazon, 10% in Tesla, 10% of Netflix 10% in Johnson and Johnson, all of that sort of stuff. And so you, the investor don’t have to worry about this because you trust me and my fund Gringotts to manage your money. And as you know, the fund performs well, because the prices of these stocks and shares increases you get the returns and I take a 1% or 2% management fee. So I make a load of money because I’m earning 1% or 2% off of this a 100 million that I’m managing and you’re not worrying about having to pick stocks yourself.
You trust me as a seasoned professional to do that for you. So that’s what a fund is. Now, the index bit refers to a stock market index. And so a stock market index would for example, be the FTSE 100 which is the a hundred biggest companies in the UK or the S&P 500, which is the 500 biggest companies in the U.S. or the NASDAQ or the Dow. And these are all different indices of the stock market. And if we use the S&P 500, for example, these are the components of the S&P 500. So we said, it’s the 500 biggest companies in the U.S. So number one is Apple and Apple makes up 6.5% of the S&P,
Microsoft makes up 5.5, Amazon makes it 4.7, Facebook has 2.2, Alphabet, which is a Google makes 1.5 and 1.5 is about 3% of the total S&P 500. And essentially we’ve got these 500 companies if you go all the way down… Oh, Ralph Lauren is 496, but chances are, you’ve not really heard of many of the other ones at the bottom of the list but chances are, you’ve heard of most of the companies towards the top of the list. So the S&P 500 is an index of the U.S. stock market. And if you look at the performance as a whole of the S&P 500, you get a general idea of how the U.S. economy is going as a whole. So this is currently what the S&P 500 looks like and if we do a five year time horizon, in fact, let’s go max.
So you can see the S&P 500 started in 1980. And since that time this is what the us stock market has been doing. So as you can see, there is a general trend upwards but for example in 2000, there was a bit of a crash, in 2008 famously there was a bit of a crash. And earlier this year, when Corona was first starting to be a thing there was a bit of a crash but then the market basically immediately recovered after that. Okay, so we know what a fund is, i.e. a way of pooling money. And we know what the index is, something like the S&P 500, when you combine those, you get an index fund which is a fund that automatically invests in all of the companies in the index. And so with me, for example basically all of my investments, all of my money is in the S&P 500, which effectively means that 6.5% of my investments are in Apple, 5.5 in Microsoft, 4.7 in Amazon, 2.2 in Facebook, 3% in Google, 1.5 in Berkshire Hathaway and so on. So why is this good? Well, it’s good for a lot of reasons. So firstly index funds are really, really easy to invest in. A big problem that beginners have to investing, it’s like, well, how the hell do I know which company to invest in? How do I read a balance sheet?
How do I do any of this stuff? If you invest in an index fund, you actually don’t have to worry about any of that. Secondly, index funds give you a decent amount of diversification. There are all sorts of companies in the S&P 500. So you’re not entirely reliant on the tech sector or the oil sector or the clothing sector or anything to make the bulk of your money. You are very nicely diversified across all these U.S. companies. Thirdly, index funds have very low fees. So because it’s not a real person who is deciding what to invest in and doing all this research and trying to make loads of money is essentially a computer algorithm that automatically allocate your money based on the components of the index fund. The fees for those are really low. And one of the main things about investing for the longterm is that even a slight increase in your fees is gonna massively impact your financial upside. And so for example, an index fund with a 0.1% fee is so much better for you than an actively managed fund where a fund manager is charging you even 1% because the longterm difference between 0.1% fees and a 1% fee is sort of absolutely astronomical over the long term.
And finally, if you look historically and, you know technically historical performance is not the same thing as future performance, but if you look historically very few funds have managed to actually consistently beat the market i.e. outperform the index. And in fact, someone like Warren Buffet famously says that if you gave him a hundred thousand pounds and asked him to invest it right now he would just invest in an index fund, like the S&P 500. And in fact, in 2008 Warren Buffet challenged the hedge fund industry to try and beat the market. He said that hedge funds are a bit pointless because they charge way too high fees and they don’t actually get the sort of returns they claim to get.
And so he set up this 10 year bet which this company called Protege Partners LLC accepted, where Buffett said that he was gonna bet that the index fund outperformed the actively managed fund. And he ended up winning that bet and sort of gave lots of money for charity or something like that. But that just sort of goes to show that it’s really hard to beat the market with an actively managed fund.
Basically, no one can predict what the market is gonna do in the future. And therefore if you hit your ride on index, i.e. you’re gambling on the entire market, rather than thinking, you know what I’ve got some amazing insight that I’ll know exactly which 10 stocks to pick that are gonna beat the market.
You might as well hit your ride with the whole market rather than individual stocks. Okay, so we’ve sorted out the problem of which stocks to invest in by completely circumventing the problem and instead, just investing in index funds. The next big question people usually have about investing in stocks and shares is the amount of risk. And that brings us to point number nine. And the argument usually goes as follows that.