9 June 2023

Should I Invest in the Stock Market

This post has a simple aim as well as a simple back story. Myself and my girlfriend were chatting on skype (i’m lucky enough to be in a long distance relationship….. in the middle of a pandemic) and i was explaining to her that i had been investing in the stock market now for a number of years. It was immediately obvious that this was something she was clearly a little startled and worried about which surprised me a little. I decided to use this as a chance to ask her what was causing her the concern and how she would feel about having her own money invested in the stock market. Interestingly the answers i got back were: 

  • I’m worried that I will lose the money that I worked hard for
  • The stock market scares me 
  • I’m worried about being scammed
  • I worry that I would have to give away my money to a company or someone I don’t know and not understand what happens to it
  • No one has ever explained it to me

The last one really hit me hard. Nobody in her life had ever sat down with her and spent time explaining the concept of investing. Is this unusual? Absolutely not; in fact it is the norm. So of course this got me thinking about how if this was how she felt then there were undoubtedly countless other people feeling just like her who I could potentially help with a post like this. 

So i’m taking it upon myself to answer all of the above questions (and hopefully others) in this post and sharing it for free to anyone unfortunate enough to stumble across this blog.

The Big One – Can i Lose all of my Money?

Whenever you speak to someone who is not an investor within a stock market one of the things they inevitably say is “aren’t you worried about losing your money” or if they’re not quite as charming it’s, “you’re going to lose all of your money”, usually with a knowing smirk.

So are they right? Can you lose all of your money? Well the answer is absolutely yes you can lose all of your money. But no you won’t lose all of your money as long as you’re not a complete fool (looking at some of you in the wall street bets subreddit) and you follow some very basic rules.

  • You invest for the long term
  • You invest in what you understand
  • You only invest with money that you don’t immediately (or in the near future) need
  • You invest in broad-based index funds
  • You diversify

Do the above bullet points help? Possibly. Maybe not. Hopefully it will become clearer as you continue reading through this blog post. But the simple explanation is, you don’t put all of your eggs in one basket and you buy a bit of everything. Do that and don’t sell anything and history states that you will always make money.

Life hack? Not really. 

Good idea? Definitely.

The Stock Market Scares Me

This is possibly the easiest question to answer. The real reason that most people are scared of the stock market – they don’t understand it. And that’s completely reasonable; how can you feel confident and safe investing money that you’ve spent hours, days, weeks, months or years slaving away for, just to trust in something that you have no knowledge of.

The stock market is a beast. It’s a confusing, complicated, ever changing beast that is controlled by fat cats who want to keep it that way. Why? So you feel the need to pay these people to ‘manage’ your money and make decisions that you couldn’t possibly be able to make yourself.

Now imagine that the stock market is a crowd of people, a crowd of strangers speaking every language under the sun, a crowd who barely even acknowledge your existence, a crowd who don’t move out of your way and who don’t care about how lost you are. However in the corner there’s a group, they speak your language, they care about you, they look out for you and they want to help you get to your destination. Who are these people? They’re index funds.

Index Funds – What they are and why they matter

Index funds are the staple of the sensible and should form the core of any balanced portfolio. These are funds which are suitable for all persons regardless of risk and as well as fantastic performance offer a complete hands off approach. It can be as simple as setting up once and leaving it alone for your lifetime.

Throughout the world there are a huge number of financial markets which are also known as indexes. Some of the most common are:

  • S&P 500 – 500 of the biggest companies in America ( Apple, Amazon & Facebook etc.). As this is the biggest individual market in the world this will be our benchmark.
  • FTSE 100 – The 100 biggest companies in the UK ( BP, HSBC & Tesco etc.)
  • Nikkei 225 – 225 of the biggest companies in Japan (Canon, Panasonic, Nissan etc.)

Alongside the above markets index funds can be even more diversified, and some of the most common examples are:

  • Developed World Large Caps – The biggest companies throughout the developed world (The above markets as well as countries such as Germany, Canada, France etc.)
  • Developed World Small Caps – Smaller companies in the above markets
  • Emerging Markets – All publicly traded companies in emerging markets (China, India, Brazil etc.)

An index fund tracks each company within the index and buys a small amount of every single one. The amount the fund buys depends on the size of the company. Apple (the biggest fund in the S&P 500 index) makes up roughly 5.5% of the market and therefore 5.5% of the money in the fund is spent buying Apple shares.

So if you were to invest £100 in an S&P 500 index fund it would look a little like this:

£5.50 worth of shares* in Apple

£5.20 worth of shares in Microsoft

£3.88 worth of shares in Amazon

£2.22 worth of shares in Facebook

…………  

…………

£0.01 worth of shares in Under Armour (#499 on the list of 500)

As we can see by investing just £100 you can own a tiny, tiny, tiny, tiny amount of 500 of the best performing companies in the world. If one company does well you benefit, if one company goes bankrupt you barely notice.

*Owning a share means you own a very small percentage of the company. A person who owns 1 share of Tesla owns just 1 of the 963 million+ shares meaning you own 0.000000104% of the company. If the company becomes more valuable then your share of the company becomes more valuable.

Benefits

  • Extremely cheap – as no expensive fund managers have to be employed and shares are not traded regularly, fees for index funds are the lowest available.
  • They outperform over the long term – Over 1 year the S&P 500 index fund beat 63% of managed funds. Over 5 years this became 78% and it only gets better for the index as the time period increases. 
  • You can buy once and forget about it – As the index is managed by an algorithm it never needs to be touched.
  • Diversified – at the click of one button you can own hundreds of the best companies in the world

So what we know from Index funds is that they are diversified, they’re cheap and they’re easy… but most importantly they make you money. In the below graph we can see how the S&P 500 has performed since 1981 and we can see clearly that throughout the last four decades the market has always trended upwards towards new all time highs. 

Does this mean everyone who has ever bought into the S&P 500 has made money?

Unfortunately no; as the market goes up and down over the short term anyone who bought before it went lower and then panicked and sold their investments unfortunately lost money.

However those people who bought (regardless of if it went down in the short term) and held their investments always saw positive returns. Some examples are below:

  • Person A who invested £100 in 1981 and held until today would have over £6300 
  • Even better is person B who invested £100 every month since 1981 would have over £640,000
  • Person C who invested £100 in May 2000 and spent 18 months watching their investment lose value until they panicked and sold for just £65. 
  • Person D who invested £100 in May 2000 and held until today would have almost £400.

*Not shown in the graph is that many of these companies also pay you money for owning their company. All the above examples assume this money is reinvested

When looking at the above examples and graph it’s obvious why one of the key principles of index fund investing is to buy and hold for the long term – History suggests it’s foolproof.

For a deeper dive into index funds a future blog post will be available which will be linked here.

I’m worried about being scammed

The year of 2020 saw the amount of scams skyrocket as people were stuck at home during the raging pandemic. At one point it seemed like i couldn’t go for more than a few days without a text coming through to my phone about a package that couldn’t be delivered – all i needed to do was log in, enter my card details and it would be sent out again the next day. I’m sure a lot of people will recognise receiving something similar as the one shown in this picture: 

Alongside blatant scams like this you will also see adverts to buy a “secrets of the stock market tutorial” or “i used this cryptocurrency guru and she turned my £300 in £70,000”. There’s only one person making one from these… and it’s not the buyer.

So how to not get scammed:

  • Use a reputable FCA registered brokerage (we will cover the best of these in another post)
  • Do your own research, don’t blindly trust others
  • Don’t buy any courses that promise to make you an overnight millionaire – they don’t exist
  • Always go directly to the website and not through third party links
  • Keep your password private and set up 2 factor authentication

Do all of the above and you should have no concerns about being scammed. Unfortunately these people prey on societies most vulnerable so the best way to counter this is to come armed with knowledge.

I’m worried about giving away my money and not knowing where it goes

Although we’ve already covered Index funds above, the best way to explain where your money goes is to again use the S&P 500 index fund as an example as it is extremely simple. This time we will use Vanguards S&P 500 fund as they are the most famous company offering these. 

When you transfer money into your Vanguard index fund this cash is pooled together with thousands of other investors’ money. Yours and their money is combined together and vanguard uses this money to purchase shares in every company within the S&P 500 index. Each person then owns a % of the fund depending on the amount of money they have paid into the fund.

If you decide to remove your money from the fund your % is sold and the cash is transferred back into your bank account. 

By having large amounts of money pooled together costs are lowered by economies of scale. E.g. it’s cheaper to complete one transaction for 10 people than 10 separate ones.

Other examples of where your money goes is a little simpler. If you pay Trading 212 (a popular free UK brokerage, your money sits in cash with them (like in a bank) until you decide to buy a stock with them. Once you buy a stock it is then registered as yours and sits in your account until you sell it. Once you sell the stock the value of the stock is available as cash for you to either withdraw or buy more stocks.

No one has ever explained it to me

I believe that one of the biggest crimes to young people within most first countries is that there is very little emphasis placed on financial education and none of it is mandatory. It is left to parents to educate their children on these matters and therefore many young people have had very little experience and knowledge of this. I am in no way blaming parents as they are merely repeating what they were taught and unfortunately they often do not know any better.

You’re lucky if your parents sit you down and explain the dangers of credit cards to you, the dangers of short term loans and the dangers of living paycheck to paycheck. Unfortunately for many of us we learn through trial and error and ultimately by having our fingers burned from the mistakes we will inevitably make.

Is the financial world complicated? 

Yes and no. Sure there are some extremely complicated loopholes and tax avoidance strategies. There are off-shore accounts and tax loss harvesting. There are accountants charging tens of thousands of pounds for their expertise but for most regular people like you and me things can easily be simplified and we can reap the majority of the benefits. Some of the below actions can have the biggest effects for all of us:

  • Always paying your credit card in balance and in full
  • Living below your means (spending less than you earn)
  • Avoiding financing your life (cars are the biggest trap here)
  • Maximising tax free accounts (ISAs and pension plans etc. in the UK)
  • Investing in a balanced portfolio (stocks, real estate etc.)

Do all of the above and you will be in a better financial situation than the majority of people in this country. Do this when you are young and you have your whole life to let compound interest work its magic and set you up for financial freedom.

Anybody who has the aim of building long term wealth and is able to save money each month should be investing in the stock market.

thenomadwallet

A 28 year old project engineer with a passion for travelling, financial literacy and learning new skills. I'm hoping that by running this blog I can track my path from corporate worker to backpacking adventurer.

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