Your friends constantly boast about their hefty returns. Your daily news feed bombards you with financial bloggers retiring at 30 years old living the dream.
You have heard enough. You want in.
Before you head all out, let us look at 5 compeling reasons to start investing in the stock market and 5 more reasons why you should not.
This is part 1 of a two part series on starting investing. Please read part 2 here: 5 Reasons Not to Start Investing.
5 Reasons to Start Investing
#1 Grow Your Money
Your money grows over time with the magic of compound interest.
The stock market is basically a market place where you can buy a small portion of a company – a share. To measure how well the market is doing, we often use something called an index.
Just like when you were in school, your teacher uses a report card to measure how well you are doing academically. Normally, your report card includes various subjects and the grades for each indicated how well you had performed.
This is not a true representative of your intelligence or your mastery of the subjects. You might had just failed to perform during your examination because you panicked not because you do not understand the subject matter.
Similarly, we have a report card that measures the performance of a market. It is referred as an index. An index is a basket of stocks that is meant to represent the market as a whole. Your subjects are the stocks of various companies in that market and the grades are the prices of each stock.
Let us refer to the poster child of indexes – the S&P 500, which contains 500 of the biggest companies listed in the US stock market.
For this article, you can assume that the S&P 500 is a direct representation of the US stock market.
The yearly returns, also referred as annualized returns, of the S&P 500 historically for the past 30 years is 7% adjusted for inflation. This means that every $100 you invest in the S&P 500, you will earn $7 by the end of the year.
With the assumption above, if I invested $10,000 in 1990, it would have grown to $76,122.55 by the end of 2019
That was pretty impressive considering that period included the dot com crash from 2000 – 2002 and the 2008 financial crisis
Yes, I get it. People always complain that the S&P 500 is a bit of an anomaly – it has been doing too well.
Ok, fair point. Let us take a look at the Singapore’s Straits Times Index (STI) also nicknamed the Super Terrible Index by Singapore investors.
Unfortunately, I could not find the 30-year annualized returns for the STI online so I had to calculate it manually from forecast-chart.
It seemed like the local press only publicised the best recent 10-years total annualized returns of 9.4% (including dividends reinvestment)
So an initial $10,000 investment in 1990 will yield $25,433.66 at the end of 30 years.
This equals to an annualized return of 3.16% from 1990-2019. Not fantastic.
But I excluded dividends so the real total returns is actually more. The average dividend yield is around 3.8%. So not too bad either.
#2 Meeting Your Financial Goals
Investing is often an important part of financial planning.
Once we have identified our financial goals, determined the total amount we need and the time period to achieve it, we often save and invest as a means to achieve these goals.
As mentioned in my previous article, investing in the stock market is a great way to accelerate the growth of your money.
Using the example above, if we had invested an additional $10,000 each year for 30 years in the S&P, the total accumulated amount by the end of 2019 is $1,020,730.41.
So the total invested amount of $300,000 will grow into $1 million by the end of 30 years.
Whether it is planning for retirement, saving for kids education or a house, investing helps us reach our goals faster.
#3 You have Spare Cash
If you have spare cash, you can afford to stay invested in the markets, especially when the markets are down.
For the financial savvy readers, you may already guessed that I am an investor that buys and holds for a long period of time. The longer the time in the market, the higher the probability of getting a positive expected return.
Let us examine a hypothetical example using the historical data from S&P to illustrate why we should stay invested in the market.
If we take a look at the S&P 500 chart, you will notice that the returns swing from positive to negative almost randomly every couple of years.
If you had invested $10,000 at the end of 1999 during the height of the dotcom bubble. How would your returns would have looked like?
Your initial capital investment will only breakeven at 2013 (14 years later).
If you needed the cash urgently in 2002 and cashed out, you would have lost $4008.88.
If you had kept your cool while others are selling, your initial $10,000 would be $22,006.33 by the end of 2019.
This was actually quite surprising to me since you would have bought at the highest prices at 1999, underwent two major market crashes (Dotcom bubble and subprime crisis) and still end up with a positive return.
Hence, if you do not need the cash, you can hold on to your positions, keep calm even during financial crisis and wait till the markets go back up again in the future.
Of course, it is easier said than done.
#4 Diversifying Your Income
Investing in the financial markets is great for generating a secondary source of income.
One common way of generating income is receiving cash dividends from stocks or coupons from bonds.
A dividend is a distribution of rewards from company’s earnings to its shareholders. A coupon is an annual interest payment made to the bond holder until it matures.
Another method of generating income is via capital gains which is basically a profit made from the sale of your investments. This would require you to sale the asset at a higher price than you had purchased it.
If you have a full time job which is quite secure and has a fixed regular income. For example civil servants, doctor or professors. You can use the stock markets to invest in riskier assets to generate higher returns.
On the other hand, if you are an entrepreneur or you own a small risky business. Or if you are a commissions based agent or freelancer that do not have stable nor regular streams of income. You may use the stock market to generate stability by investing in fixed income assets that provide stability and regular incomes.
Other kind of diversification is investing in sectors that are not correlated to the sector which you are working in. When your sector is not doing well, your investments might still fare better.
So if you are working full time in the oil and gas industry, you might want to invest in renewables in the stock market.
Or you may choose to invest in international markets when you work in a local small medium business that is heavily dependent on your local economy. So when your home country is not doing well, your investments might still do well can still generate some income.
#5 Learn Investing
Everybody is an expert when it comes to finance, or so they claim.
Anyone can preach how to make good investments – buy low sell high. Do not follow the herd, always stay invested, do your research, understand the business, understand the market, look at macro economic trends, pay attention to the indicators bla bla bla…
But why aren’t most people successful?
The financial industry is quite complex and confusing. It is only when you start to dip your toes, you begin to realise so many details that were hidden from us lay people of the financial world. For example, fees. So many hidden fees in financial products!
Before you start investing, you often do research on the strategy, identify the approach and plan everything. However, the hard part about investing is also about implementation.
For instance, once you put your money in the line, you realised that you are probably not as rational as you think.
It is easy to say: ‘stay invested even when the markets drop’. If you have just a few months worth of salary invested in the stock market, a 20% to 30% drop doesn’t feel that terrible, just stay invested. Afterall you could easily recoup the loss after you get your year end bonus.
However, when you have 20 years worth of savings invested in the stock market and then the market drops 20% to 30%, you start to panic because a realisation suddenly strikes you: Your 20 years of hard-earned savings might just vanish just in a mere few hours.
Those few mistakes or those few losses, might just provide you much better learnings than education or reading on financial literature.
Also, always seek professional help if needed. Good financial advice is worth its weight in gold.
Read up and understand the basics. Get good advice. Get started. Learn, track progress, review and adapt.
Let me know what you think. What is the most compeling reason for you? I would love to hear your feedback.