Saving for the future using a savings account, is a safe but inefficient way of accumulating wealth at the best of times, but with low interest rates, your money is doing very little for you.
There is a better way. Make your money work harder through investing. It does not matter how little you have - a few £ or $ invested on a regular basis will do. What matters is time, and when you are young, you have lots of it.
Like some of you, I started out with absolutely nothing and I've lived through
economic hardship. I started investing in the late 90's, made rookie
mistakes, seen booms and busts but I've also made money and today I'm significantly better off, financially, due
to the actions I've taken.
You
don't need to be a financial whizz. Investing is easy compared to 5 or 10 years ago - but like anything else, you do have to put some
effort in to get the best results. Today you can invest from your phone, get the information you need to help you decide what to invest in for free and there are no fees or minimum balances to eat away at your hard earned
cash.
Yes, there are risks with investing especially if you have short term needs. If you plan to save for a year or more - then consider investing. History shows that medium to long term investing will deliver more gains than your savings
account.
To illustrate why investing makes sense, take a look at these charts, the
S&P and Nasdaq (US markets) and the FTSE 100 (UK market), from the year 2000 to 2020.
You
can see the dips from the market crashes (2001, 2008, 2016 (UK), 2020. If you sold during those periods, you could
have lost money, depending on when you started investing.
However, look at the long term trends indicated by the pink line. If you had
not sold in any of the crashes you would have regained and made up your money with time.
In 2020, the crash occured in March and by July, anyone who had invested in
the market previously (or post the crash) would have been taking profits as the markets bounced back. If you had
invested right after the crash, then you would have made a considerable amount of money - depending upon where
you invested it.
3 do's
and don'ts to remember at all times
Before you are ready to invest, consider these three do's and
don'ts.
Do
- Do invest in your 1. health (mind and body), 2. relationships 3. wealth
(in that order).
- Do invest to suit your age and objectives. Young? invest in equities
(shares) and real-estate to create wealth. Much older (or rich)? invest in bonds, gold, art to
preserve wealth.
- Do invest with a logical mind. Understand what you are buying and why you
are buying it and when you want to sell it.
Don't
- Don't let anyone else manage your finances. Only you should control your
future.
- Don't invest if you have debts. The interest on debt, like loans or
credit cards, is guarenteed while any money made through investing is not.
- Don't let emotion control your actions. Don't be too quick to act (buy
or sell) or you may be regretting it for a long time.
Investing in equities, that is, shares sold on the stock market, can be
accomplished through several methods. Each option depends on your circumstances and comfort.
Index
Tracker
One of the simplest methods of investing is a
basic index tracker - an investment that tracks a market, like the charts shown above. Index trackers are
funds that consist of many different stocks, providing
instant diversification in one simple, low-cost investment. For example, SPDR (symbol
SPY) is a fund that holds stocks in 500
companies like Apple, Amazon and Facebook. You don't need to buy individual shares to own a piece of Apple
or Tesla!
Instead of trying to outperform a particular stock market, index trackers
track its performance. As these funds are passively managed
(there's no analysts or fund managers to pay) their costs are extremely low or zero in many cases. If you're
in the UK, tracker funds can be held in an ISA. (Tracker funds can also be held in a pension fund as
well).
Exchange
Traded Funds (ETF)
An ETF is a fund that tries to outperform a specific index or market.
As these are actively managed by an analyst or fund manager, buying or selling equities into or out of
the fund, they incur charges but those charges should be minimal compared to the gains. Historically
ETF's had a mixed track record with some performing worse than a basic index tracker. Recently
there have been a number of actively managed funds that have been deliverying better than average or
spectaular returns - such as ARKK, QQQ, TQQQ or VGT.
If you are just starting out with investing, the general concensus is
that Index trackers or ETF's are your best bet to begin with. Jim Cramer, a long time investor recommends that you invest in an ETF until you
have raised $10,000 before buying individual stocks yourself. (Wise advice I wish I had early on
when I had started out). Funds tend to focus on specific themes, such as clean energy or electric vehicles,
so if you are interested in an area, but don't want to risk putting your money in a single company, this is
a good way to invest.
Dividend
stocks
Would you believe that some companies pay you for owning their stocks?
Companies like Coca-Cola, Johnson and Johnson and Target pay a dividend, thats cash to you and me, for every
share you own. These companies are considered "stable", that is, their share price is not going to sky
rocket or plummet, because their growth is more predictable. In the UK most companies pay dividends twice
yearly but in the US many companies pay every quarter. There are companies who have paid out dividends
consistently for many years - these are known as Dividend Aristocrats. Over time, dividend stocks are a great way to accumulate
wealth without the worry of rising or falling share prices - infact lower prices are better for you at
dividend payout time if you use the dividends to automatically buy more assets of the same company. I will
write a follow up post about dividend investing as this is a good option for a cautious or conservative
investor.
A
word about Tax - yes you need to read this bit..
Last year (2020), many new investors were caught out because they started
trading and were unaware of the taxes incurred when trading. If you are of taxable age, there are two types
of taxes you need to be aware of.
- Dividends you receive will be taxed as income at your
income tax level.
- Profits you make from the sale of assets (ETFs, Index trackers or
individual shares) incur capital gains tax (CGT). (Losses result in a CGT reduction).
If you are in the UK, you do not pay capital gains tax on ISAs
or PEPs and you have a tax-free capital gains tax
allowance of £12,300 and then CGT is charged at either 10% or 20% of gains depending upon your
tax band.
In the US, capital gains tax is charged at different rates depending on how long you
hold equity before you sell it and your income level. Selling any asset, held for less than a year, incurs short term capital
gains tax and is taxed based on your income level (rates
range from 10% to 37%).
Long-term
capital gains tax rate is 0%, 15% or 20% depending on your taxable income. For example, if you earn
less than $40,000 a year you will pay $0 in long term capital gains tax.
If the thought of paying tax on your gains worries you - then wait ! It's
a nice problem to have.
Here's a basic calculation if you are in the UK:
Your taxable income is £20,000.
You made £12,600 in profits from your sale of assets.
Your CGT allowance is £12,300.
To calculate the tax owed:
Deduct the CGT allowance from your profits. £12,600 - £12,300.
That leaves £300 to pay tax on in our example.
To get the tax rate, add the £300 to your taxable income (£20,000
+ £300).
Because £20,300 is less than £37,500 (basic rate tax band), you pay CGT
at 10% of the £300.
This means you’ll pay £30 in Capital Gains Tax.
£30 tax on £12,600 is pretty cool eh?
When you are starting out in your career, investing makes a lot of sense
as you are likely to be in a lower income tax band and have more time to buy and sell assets at a lower tax
rate.
Now that you understand that CGT is taxed at a lower rate than income
tax, in most cases, the question you should be asking yourself is - "should you work extra hours in overtime
to earn extra money racking up a larger income tax bill or should you be spending more of your time
investing and taking advantage of capital gains?"
So
why is investing attractive right now?
There are many reasons to get into investing right now, but here are the
3 reasons that compelled me to write this post (other than wanting you to get started in securing a better
future for yourself):
1. Climate change
and shift in tech, services, industry and agriculture
required to address it.
2. COVID - the market crash and recovery provides many opportunities
to invest at a discount
3. It has never been easier or cheaper to invest through commission
free mobile apps
Climate change is disrupting
- the car industry. For the first time in 100
years the electric car is now considered the future for personal transportation.
- the energy industry with a shift to clean energy sources (solar, wind, hydrogen etc).
Disruption in any market provides you with an opportunity to invest with potentially high profit - for example Amazon disrupting the retail market in the early 2000's.
Right now interest rates are at historic lows. You might not understand
why that is important (other than it means you earn peanuts on your savings account) - but it means that
governments can borrow money to fund large scale projects, such as infrastructure development or to hand out
subsidies in areas that require investment - such as electric vehicles or clean energy. We need
governments to invest to help protect our future. We know that climate change is real and it will require
many different approaches to address. That much is certain - and where you have certainty you have an
opportunity to invest and make money while supporting a good cause.
How
can you start investing ?
Before you install and app and start trading I should point out something
that I will cover in detail in a future write up. When purchasing anything, by default most apps will
purchase at a market rate - unless you change the purchase option. DON'T purchase at the
MARKET rate! You cannot guarentee what that will be - despite the price listed on the screen -
you will often get the next best price someone is willing to sell at - not the one you want to purchase at.
So at least for now, if you do make a purchase use a LIMIT order only. This says that you will only
make a purchase at a specific price.
Rather than recommend a specific app I recommend you read the following
reviews of apps and decide which app your prefer based on your circumstances. (I don't use any of the UK
apps as I am based in the US).
Things
I didn't write about, but will in a follow up post
1. Basic trading
2. Dividend investing
In
the meantime check out ..