Lesson 4: Investing Basics and Long-Term Thinking

Introduction to Investment

Investing isn't as complex as it sounds․ At its most basic‚ it means making your money work for you by putting it somewhere it will grow over time․ The difference between saving and investing is simply that when you invest‚ your money is working for you while you wait (OECD, 2022; Bank of England, 2023)․ Saving is generally safer and more stable because your money is typically going into a bank account and is usually (but not always) earning low or low-friction interest․ Investing means putting your money into things like stocks and bonds‚ with the hope that your money will grow over a long time horizon․ The value can increase or decrease․

Stocks & bonds

Stocks are ownership in a company․ When you buy a stock‚ you're basically buying a tiny piece of that company․ Bonds are very similar to stocks but they are closer to loans․ A bond is a loan to a government or business that they pay back with interest․ Funds are similar‚ but they let you pool money with other investors and invest in lots of different stocks or bonds․ Instead of being exposed to a single company‚ you are spreading your risk across many (Malkiel, 2019; Vanguard Research, 2021)․

Investment Advice

The concept of spreading risk is one of the building blocks of investing called diversification․ This is the same idea as don't put all your eggs in one basket․ If one company does poorly‚ hopefully another company does well and balances the investment out at an overall portfolio level․ In this way‚ diversification reduces risk‚ but does not eliminate it (Markowitz, 1952; Bodie, Kane & Marcus, 2021)․

The power of investing is time; the sooner you start investing‚ the more time you have for your money to grow․ This is because of compound interest‚ where you earn interest on the money you invest‚ as well as on the interest your money earns at every point in time․ Thus‚ a small but periodic investment can grow to be worth a lot of money over long periods of time‚ with the initial impact being negligible and accelerating like a snowball rolling downhill (Hull, 2022; CFA Institute, 2023)․

Long-term impacts

This is why time horizons matter․ If markets go up and down‚ a short-term investor panics; a long-term investor knows that up and down markets are normal over long periods․ Over long periods of time‚ in fact‚ decades‚ markets tend to straighten out and the economy tends to grow so if you're patient you're going to do all right (Siegel, 2023; Fama & French, 1988)․

The hardest thing to do is not the math‚ it's the psychology․ When a price goes down‚ you feel like you lost money․ You lost money‚ but you didn't lose money‚ you just lost paper profits․ You want to do something when a stock price goes up‚ but long-term investing is usually about doing nothing․ It's about not overreacting and staying true (Kahneman & Tversky, 1979)․

Investing is not about how to get rich quickly․ It's about putting your money to work to harness the power of compound interest to make your goals happen․ The secret to investing isn't about timing the market‚ it's about time in the market․

In the end‚ it's not prediction‚ but patience that wins out․