There are definitely good reasons to begin investing. By going from a borrower to a lender and investor, interest payments start flowing your way instead of flowing from you into someone else’s pocket. You start being able to buy things you want using money that you did not need to earn through the sweat of your brow, rather than working extra hours to pay the interest for something you bought on credit.
By putting off purchases – acting like a grown-up and delaying pleasure rather than like a two-year old and demanding everything now – you get to have the things you want and the cash needed to buy it. You get to have your cake and eat it too. That vacation will seem sweeter and that car will drive better when you won’t have a payment slip waiting for you at home. You may even get to pay less for things since most sellers will give a discount to those with cash.
When looking at different investing options, there are many choices to consider. Among the choices, going from the least risky to the most risky, are savings accounts, money market funds, government savings bonds, treasury bonds, paid-for real estate, municipal and corporate bonds, preferred stocks, common stocks, penny stocks, warrants, commodities, and options. Despite common stocks coming near the end of that list, meaning that they are more risky than many investment options, there are good reasons to begin investing in the stock market. These are as follows:
1) Stocks can beat the rate of inflation, leading to growth in capital. Of the options on the list, those that come before real estate will not provide enough of a return to beat inflation. This means that the money in those instruments is decreasing in value each year. If you need the money in the next few years, this will not make much of a difference. But if you are saving for retirement, the dollars you invest today in money market funds, treasury bonds, and the like will be worth only a fraction of their value when you retire. Real estate (that you buy fully for cash) will on average just track the level of inflation (although there are special situations if you are investing in specific properties and know what you are doing). Penny stocks, warrants, options and the like significantly increase the risk that you will lose your money in a short period of time. Common and preferred stocks hold a nice place in the risk curve where you can beat inflation but can put the odds in your favor.
2) Long-term holding of stocks allows compounding through the delay of taxes . Capital gains taxes on stocks do not come due until the stock is sold. This means that investors who hold stocks for long periods of time get to enjoy the benefit of compounding for years without paying taxes on the capital gains until the shares are sold. Warren Buffett and Bill Gates have paid very little in the way of taxes, despite their enormous wealth, because most of their wealth is in stock in their companies. Because they sell only a few shares each year, their tax bill as a percentage of their wealth is very small. Warren Buffett will actually never pay taxes on the bulk of his wealth because he donated it to the Bill and Melinda Gates Foundation.
By contrast, those earning a paycheck see 25-35% of their earnings taken by state and federal income taxes and another 15% taken by payroll taxes before they even see it. Note that if the stock is held in a mutual fund, capital gains taxes will be due if the mutual fund sells shares in the fund at a profit and distributes the gains to you even if you do not sell shares of the mutual fund. This is one reason to find funds with a low turn-over or “churn rate.”
3) Investing in stocks requires much less effort than some other types of investments. Real estate can be a great investment if you know what you’re doing, but you often need to have it as your hobby. If you want to buy, renovate, and resell houses count on spending many hours at the house doing a lot of the work. Even if you contract the work out, losing much of your profit, you will rarely find someone with as much commitment to the project as you do since it is your house.
If you rent houses, count on doing a lot of repairs yourself late at night, or paying a fortune to others to do it. Because they are not paying for it, it matters little to renters that Sunday rates are 2 to 3 times weekday rates. They would probably be more willing to sweat a bit if they were paying for the air conditioner repairs on a Saturday night.
With long-term investing in stocks, you simply need to spend a little time finding stocks to purchase, call a broker or enter trades on a website, and then monitor the stocks once in a while. Because good investing is long-term and based on the business, rather than on the short-term fluctuations in price, it really doesn’t require a big time commitment. Just once in a while check on things, read the annual reports to see that the company is still doing what you bought it for, and then leave things alone. In times when the markets are going down, taking everything with it, it is actually better to ignore your holdings for a while rather than sell off in a panic at low prices.
For even less care and feeding, a set of index mutual funds can be purchased. In that case, the only maintenance required is to rebalance the money in the funds once a year. As retirement nears, more and more of the funds are sold to raise the cash needed for living expenses.
While other investments deserve a place in one’s portfolio, common stocks, either bought directly or through mutual funds, definitely deserve a prominent place for money that will not be needed in the next 5-10 years.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
