There’s no better time to learn how to invest than when you are a student.
Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”Albert Einstein
One of the best ways to leverage compound interest to your advantage is through investing.
As a student myself, I am constantly swamped. So I know how tough it can be to squeeze out time to learn about investing. But knowing how to invest is something that almost all wealthy people have in common, so it’s worth taking a little time to figure out what it’s all about. In this post, we cover different kinds of investments, how even a little bit of contribution can make a huge difference, and even how to automate it so you can focus on your studies! Ready? Let’s get right into it.
The magic of compounding
In the Psychology of Money, Morgan Housel claims that human minds are not built to handle the “absurdities” of compound interest. Let’s test that theory.
Historically, the stock market has returned 10% every year. This means that if you invested 1 dollar today, one year from now, it would be worth $1.10. Let’s say you’re 20 years old and plan to retire at the age of 65, which gives you 45 years to compound your money. Let’s also assume that you invest $1000 today into the stock market and don’t put another penny in for the next 45 years. Using historical assumptions, how much money do you think that $1000 would turn into?
$3,000?…….. $7,000?………. $10,000?
Nope, nope, and nope. Assuming the stock market performs exactly as it has for the past 100 years and you just let your money sit there, your $1000 would turn into over $72,000! That’s more than 70 TIMES the initial amount of money you put in, and that’s with you not adding a single penny after the initial $1000. When you start factoring in additional contributions, the numbers start to seem even more ridiculous.
Let’s say you find a way to save $5 every day. (And before you say “I can’t save $5 every day,” just remember that I am a student too… I’ve SEEN how much those Starbucks Iced Guava Passionfruit Drinks cost). So let’s assume that you save just $5 every day and toss it into the stock market along with your initial $1000. How much money do you think you would have when you retire?
Ready for this? You would have $1,425,208.35. That’s one million, four hundred and twenty-five thousand, two hundred and eight dollars. Consistent investments will make you a millionaire! And THAT is the power of compounding.
Two easy investment types
As a busy student, you probably don’t want to hear about technical analysis, and PE ratios, and EBITDA margins. Good! I don’t either, and that’s not what we’ll be talking about in this section. Instead, we will be giving a brief rundown on two investment types that are easy to understand and easy to buy. The two types we’ll be chatting about are stocks and ETFs.
The word “STOCKS” pops into my mind in big flashing lights whenever I hear the word “investing.” That might not be the case for you, but needless to say, stocks are a key part of almost any investor’s portfolio.
A stock is basically just a piece of a company. If you own 51% of a company’s stock, you own a majority stake and can actually call the shots around the place. The price of stocks changes because the companies’ perceptions in the eyes of the public change. It’s just like any other thing in the world: the price is settled via many buyers and many sellers.
“Hey, want to buy my used textbook for $100?”
“No, that’s way too expensive, plus Carlos is selling for $90.”
“Hmm, ok, I can do $93.”
“… ok deal!”
Because both the buyer and seller agreed to the $93 price, that price is what the textbook is worth. Stocks are the same. If both a buyer and seller agree on the price of a stock, then that will be the price of the stock. Of course, when I say “a buyer” and “a seller”, I am referring to ALL of the dynamic interactions between ALL the buyers and ALL the sellers, but we won’t get into that.
There are two main ways to make money on stocks: capital gains and dividends. Capital gains are when you buy a stock low and sell it high (if I buy a stock for $100 and sell for $110, my capital gains is $10). Dividends are like Starbucks’ loyalty rewards. It’s a free reward for trusting the company. In fact, if you buy $1000 worth of Starbucks’ stock, every year they will give you $17.6 (since their dividend rate is 1.76%) JUST for owning their stock!
Now, stocks are cool and all, but there is one very real risk. The companies you invested in could fail and go bankrupt and take all your savings with it. This is where ETFs come in to save the day.
ETF stands for Exchange Traded Fund. What an ETF is, is a bundle of stocks that you can buy and sell just like one singular stock. For example, a really popular one is SPY. If you buy SPY, you automatically own a chunk of every single one of the top 500 companies in the US.
“Wait, but won’t that cost me a bajillion dollars to own 500 companies?!”
Nope, SPY currently sits around $380. By buying one share of SPY, you probably won’t own a “whole” stock of any company, but you will own a little bit of them all.
The great thing about ETFs is that a lot of companies within the ETF can fail, but as long as a few do well, the overall ETF will still do well. They are the epitome of diversification, and a lot of actual managed funds don’t outperform SPY (the biggest ETF).
Personally, I don’t have the time or the energy to analyze a hundred companies and then pick one that I think will be a winner. Instead, I just buy them all with an ETF!
How should you invest?
Hopefully, I’ve piqued your interest enough for you to start investing. But how to begin? Well, as previously mentioned, you can do one of two things for good results over time:
- Spend time analyzing stocks and constantly learn more about investing so you can pick consistent long term winners
- Toss money in an ETF/index fund
If you want amazing returns in the range of 20%-30% on your money every year, then I would go for the first approach. But, if you’re like me and don’t have the time nor energy and are okay with 7%-10% per year, I would recommend buying into a general stock market index fund (ETF), leaving it alone, and continually adding to it. A few good ones to start off with are SPY (500 biggest companies), NASDAQ (tech companies), and Dow Jones (30 largest companies in the United States.)
Automate your investing
If you do decide to invest in an ETF or index fund, I have good news for you. You can automate it! Yup, that’s right, you can set it up once, never worry about it again, and get back to your studies.
I don’t know your exact banking situation, but this WILL require for you to at least have a brokerage account. This automation can be called various things, but go to your online banking and try to find something along the lines of “pre-authorize deposits” or “pre-authorize payments” or even “pre-authorize bills.”
Find out where you can pre-authorize sending money every month. Once you have that sorted out, set the amount to an amount you can afford to contribute every month (this is different for everyone). Then, set the receiving account to your brokerage account.
The last step is to call up your brokerage company and tell them that you want to pre-authorize periodic investments. Ask them if this is an option and tell them you’d like to set it up. Then, just tell them to buy as much of a certain ETF/index fund as they can with the money deposited every month (this is where you pick an ETF you like).
And that’s it! Once you’ve done that, you don’t need to worry about it ever again and money will be automatically added to and invested in your brokerage account!
Investing relies on the magic of compound interest, and compound interest works best when you have time on your side. The earlier you start, the better, and as a student, there’s really no better skill to learn which can bring you as much potential wealth as investing.
In this post, I’ve shown you the importance of investing, two easy investments, and even how to automate it. So what are you waiting for? Get out there and start compounding your money! Your future self will thank you for it 😊