How Does Investing Work? It’s Simpler Than You Think.

Putting your money to work is nothing new. We’ve always known that it takes money to make money. Nothing’s free in life. 

But, how does investing work? Where do you find investments? Understanding the answers to these questions is foundational to your success as an investor. 

Don’t worry. It’s not difficult to learn. It’s different—a new language. Keep reading to learn how investing works. It’s time to build wealth like millionaires.  

What is investing? 

Investing is using money to buy assets like–stocks, real estate, loans, royalties, currencies, art, crypto, and more–in the hopes that they will increase in value over time. 

Companies (individuals, too) have long turned to investors to raise capital or make a profit. It keeps the business growing. 

For a long time, investing was complex and reserved for the ultra-wealthy. However, today anyone can be an investor. Once you know how it works, you can put your money in the game. There’s no excuse with online brokerages with commission-free trading. You can invest with as little as $5.

How does investing work?

Investing works through time (compound interest) and value. Over time assets are seen as more or less valuable, causing their price to increase or decrease should a sale take place.

For every investment, there’s a buyer and a seller. Buyers and sellers negotiate a price for the asset. So, when there are more buyers than sellers, demand is higher than the supply, causing the price to increase. Alternatively, more sellers than buyers leads to low demand, high supply, and price reductions. 

Following negotiations where sellers place their ask and buyers set their bid, the sale takes place upon an agreed-upon price. After that, the buyer owns the asset until it’s sold (at a profit or loss) or it’s worthless. 

Top-quality investments increase in value exponentially over time. One day you’ll wake up and see the returns.

Compound Interest and Value

Now let’s go through an example of how compound interest investing in stocks works. Say you want to start investing and have an extra $1000 on hand. But you don’t want to invest anything else.

Assuming a 10% rate of return each year, your $1000 invested today would be worth:

– $1100 after one year

– $1210 after two years

– $2,593.74 after 10 years

– $6,727.50 after 20 years

– $17,449.40 after 30 years

By investing, you can quadruple the value of your money without investing another dollar.  

Compound interest is interest that you earn on your money. When reinvested, it has the potential to speed up the growth of your investment portfolio. 

The magic of compound interest materializes when the money you invest continues to earn more money whether you increase your investment contributions or not. Compounding intensifies the longer you give your money to grow, building your wealth over the long run. 

Compounding depends on your investment strategy. For instance, if you choose a high-risk approach to investing where your portfolio focuses on growth investing, your investments are likely to grow at a higher return rate than a more conservative investment strategy such as value or income investing.  

Types of investments  

Investors invest in assets based on their risk tolerance. Investing in riskier assets can grow investments faster, but increased portfolio volatility is likely. Conversely, safer investments have less risk, but the growth is slower.   

There are lots of ways to invest. And having a portfolio with multiple options minimizes risk through diversification. Don’t put all of your eggs in one basket. 

Traditional assets include:

• Individual stocks
• Bonds
• Real estate
• Commodities
• Index funds, Exchange-traded funds (ETFs)
• Currencies 
• Small business of your own

Alternative investments fall under:

• Collectibles such as vintage cars, fine art, and even the Birkin bag!  
• Cryptocurrency
• Non-fungible tokens (NFTs)
• Wine
• Peer-to-peer lending
• Crowdfunding real estate
• Crowdfunding small businesses

There are risks and benefits with all types of investments. Only you can decide what works for you. Never invest with money you can’t afford to lose or money you’ll need in the next five years. Instead, choose the path that best meets your financial needs and goals. 

Why investing is important

The dollar you earn today is worth less than you make tomorrow. It’s called inflation. Every dollar loses its purchasing price as the costs of living increase. For example, ten years ago, $50 worth of groceries doesn’t buy $50 worth of groceries today. Unfortunately, it’s way less.

The average pay raise in the United States is about 3%. At the same time, the average rate of inflation averages 2.5%. So investing helps your dollars keep up with inflation. 

The dollar you invest today has a pretty good chance of being worth more with investing. Investing is one of the best means to increase your net worth over time. 

However, investing is more significant than you and me. It’s about the world. It’s about building businesses that enhance our quality of life. It’s about building wealth for your children’s children’s children. It’s about freedom, time, and your financial future.

What’s not investing  

We’ve covered how investing works. Let’s take a look at what’s not investing.

Saving and investing both involve storing money for a future goal. But the purpose of saving money is short-term, such as keeping some money aside for an emergency fund. So there’s no risk with saving (other than losing value because of inflation).  

Just like saving, day-trading is not investing. Many traders may think they’re investing–but they’re not. They’re not trading stocks. Instead, they’re trading contracts because they don’t own the stock like investors. Traders speculate with frequent transactions based on short-term market volatility with the hope of making a profit. 

Investors take a long-term outlook, ignore short-term fluctuations and ride out losses. 

How to start investing 

Here are five simple steps to start investing.

1) Get to know your risk tolerance and understand your investment options. You can invest in just about anything that you want to. You can invest in a small business for yourself or someone else through crowdfunding. You can invest in stocks in the stock market. Maybe you like real estate and want to be a landlord. Perhaps you want to flip properties or just invest in them through peer lending or crowdfunding. You have many options to store your money in assets that will make money down the road. But do your homework first.

2) Decide on how much money to invest. Make a budget and then decide how much you can afford to invest. Suppose you’re short money to invest. Consider starting a side hustle or a weekend job to make extra money. The amount you need to invest will depend on your age and your cost of living. It’s a personal decision.

3) Decide where to invest. If you’re looking to invest in stocks, open a brokerage account with an online broker that offers free trading like TD Ameritrade, Charles Schwab, Vanguard, or Fidelity. If you want an all-inclusive option for banking and investing, consider M1 finance. 

If you’re interested in real estate, you can turn to a realtor to help you get started. Looking for options in crowdfunding real estate, check out Fundrise, CrowdStreet, and DiversyFund to name a few.

4) Think long-term and choose your investment strategy. Investing is a long-term investment strategy. It can’t be done overnight. Make your plan fit your knowledge, risk tolerance, and level of interest. Don’t make a plan that requires active involvement if you can’t handle looking at good and bad ones.

5) Automate your contributions to your investment account. Whatever you decide for investing. Make sure you can automate it. Investing isn’t a one-time thing. You need to find something that you can grow over a long time-horizon. For most of us, this will be stocks. 

Dollar-cost averaging will minimize the risks of investing in the stock market by averaging stock market highs and lows. 

6) Take care of your personal finances. Make a budget to minimize bad debt and cut expenses. Maximize your cash flow to fund your investments now so that you can enjoy them later.

Bonus: What is Microinvesting?

Micro-investing is investing small amounts of money (like spare change) over time to maximize compound interest. Investors like micro-investing for its simplicity and automatic investing in broad index funds, ETFs, and mutual funds. It works like investing in stocks, but usually with a Robo advisor on a much smaller scale. 

Micro-investing allows you to start investing with little money. It puts your money in a diversified fund that adds up over time. Small investments make saving a habit. 

Some of the micro-investing platforms charge users a monthly fee that can cut into returns. However, if it’s going to get you in the game, we think it’s worth a few dollars. You can find options for micro-investing through Acorns, M1 Finance, Stash, Public.com, and Greenlight.

The Bottom Line

Growing money isn’t complicated. Invest it. It’s the best way to keep up with inflation and build wealth to own your time. Learn how to invest and make an investment plan. Today, you have so many investment choices. 

Of course, your return on investment is not guaranteed, but with education, diversification, and good decision-making, you can build wealth. Your investment journey will have highs and lows as the value fluctuates according to supply and demand, market sentiment, world economics, and company performance. But sometimes, you have to take a chance. Scared money don’t make money.