Hello everyone, todays lesson focuses on can you afford to invest?.
Our last lesson focussed on why should you invest? and we put it down to three main reasons. Number one was of course to make money, number two was to try and beat inflation and number three was about building wealth over time or saving for the future.
So now we understand better about why we should invest, lets dig a little deeper into whether we can afford to.
One of the first and most important things to say is dont risk what you cant afford to lose forever. While last time out we covered the historical returns of certain stock markets, there is of course no 100% guarantee that you will make money investing as past performance isnt a predictor of future results. Going into investing with the mindset that you are risking what you can afford to lose is a good place to start, and will help make your investing journey psychologically easier.
There are three useful questions that you can ask yourself to help you better understand whether you can afford to invest:
- Do you have an emergency fund?
- Am I committed to leaving the money in place for 2-5 years or longer?
- Can I weather the ups and downs of the markets?
Lets go through these in a little bit more detail.
Do you have an emergency fund?
If you lose your job or say vital repairs are needed on your house, have you got money to see you through for a while? We know there is no way of predicting when these emergencies could happen but it can be very useful to have an emergency fund available to you regardless.
Some money planners recommend the 50/15/5 rule, with the 5 representing 5% of your take-home to be for short-term savings such as an emergency fund. For this rule, 50% should be allocated to all of your essential expenses like your house and so on, and 15% should be for investing in your retirement.The rest of the 30% could be spent on discretionary expenses, like holidays, socialising, entertainment or more savings.
Am I committed to leaving the money in place for 2-5 years or longer?
If the answer to the question above is no, then you are going to struggle to really see the benefits of investing. In the last lesson Why should you invest? we talked about the power of compound interest and the benefit of reinvesting your returns year after year. But if you are not committed to leaving your money in place for a few years, then it might be more beneficial to focus on getting into a position where you can be. A risk of investing in just the short term is that you may invest during a period where the stock market really struggles and could therefore end up losing money, but by having a longer-term mindset, you increase the chances that you will eventually see a return on your investments.
Can I weather the ups and downs of the markets?
Now this kind of follows on from what we were just talking about. Unfortunately, markets dont only go higher (wouldnt it be amazing if they did).
As mentioned earlier, the most invested stock market in the world, the S&P 500, averages around a 10% a year return over the last century and has positive yearly returns over 70% of the time. Stats like this can make us feel more confident in long-term success when investing but there are of course some years when the stock market finishes lower. We need to understand that. There will be periods where markets struggle and when losses occur, but by regularly investing, having a longer term mindset and also not investing more than we can afford to lose we can weather these periods.
Fractional shares
Next up, we are going to dive into fractional shares and how they have made investing more accessible to us all. What is a fractional share you say? A fractional share is a part of one share of stock. For example, if the price of a stock is $1,000 and you invest $10, you own a fraction of that single stock. At TBanque, you can buy fractional shares of any size above our investment minimum of $10. This gives you the opportunity to access more expensive stocks with less capital.
Fractional shares havent always been a thing, as back in the day if you wanted to invest in a company that was trading at $500 per share, you would have to invest a minimum of $500. There was no option to own half of it by investing $250 and so on. This of course priced a lot of investors out, so once fractional shares became mainstream over the last few years, we saw a big rise in younger investors.
Another benefit of fractional share investing is that it makes diversifying easier. Regardless of the share price of different stocks, you can invest in multiple companies. We will continue to cover more about diversification in more detail as we go through this Summer School course but it can be a great risk management tool and is something we will put even more focus on.
Getting started
If you dont think you are ready to start investing yet, you might want to consider how can I get to the point where I am? How can I save better?
The 50/15/5 rule we covered earlier isnt a bad place to start. Were not going to say if you give up spending ?3 a day on a coffee youre going to turn into Warren Buffet by the end of the year, but by spending less on discretionary things such as coffee and takeaways, you could be in a much better position to start investing.
Even if you managed to save ?100 more from saving better you can see pretty good returns by investing that each month over the long term. Lets say you only managed a 5% return (which is half of what the US Stock market returns remember) and lets say you invest ?100 a month with a 5% annual compound interest rate, you could make ?160,000 in 40 years. So by not having that extra coffee, chocolate bar or side of chips with your takeaway you could actually see some pretty decent returns over time.
Conclusion
In summary of this lesson, hopefully you are now in a better position to understand whether you can afford to invest. Weve covered three questions to ask yourself that should help you better know, the benefits of fractional share investing, the importance of not investing what you cant afford to lose, and how the 50/15/5 rule can help you out as well. In terms of when you decide to invest, ultimately it is up to you but one way some do it, is in line with their payday which might not be a bad place to start.
See you in the next class we will cover whens a good time to start investing?.
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