In The Beginner’s Guide to Investing – Part 1 we learned that there are different types of investment accounts, and these accounts act kind of like cookie jars – we can own them, but without any cookies in them (the investments), we’ll be sad.
There are literally hundreds, if not thousands, of different types of investments we can buy. This is part of the problem.
Imagine you need a new waffle iron and you walk into your local supermarket only to be presented with 700 slightly different and unique waffle irons.
You would be angry! How in the world are you supposed to buy the right waffle iron if it takes you two months to sift through all the different kinds?
So it is with all these different kinds of investments. But like we learned in Part 1, 90% of the investment information out there simply isn’t relevant to the average person like you and me.
So we’re going to focus on the single most popular type of investment that average folks like us use – company stocks.
What are Stocks?
Stocks are shares of ownership in a publicly owned company.
If you’ve ever heard of a company “going public”, that means a company that was privately owned is choosing to become publicly owned, which means they are going to sell shares of ownership in the company to us – the general public.
There are thousands of publicly owned companies just here in the United States, and we have the amazing option of purchasing shares of ownership in those companies.
For example, we could buy 20 shares of Amazon stock inside of our 401k account. Those 20 shares are the cookies inside our 401k cookie jar.
We could also buy some shares of Netflix and maybe a few shares of Facebook. Maybe add some Nabisco and Walmart all inside our 401k cookie jar. All those shares will cost real money and each share of stock will be sold to us at a certain price.
Now that we’ve got some cookies in our cookie jar, we’re investing.
And here’s where we have to understand the biggest difference between money in a savings account and investments in an investment account.
Money We Invest is Risky
Money in a savings account won’t disappear.
Money in a savings account is static. It won’t change except for the slight bump we’ll get from the measly interest we’ll earn on our money, but our money will never go down in value or just be gone.
Investments are the exact opposite. The value will change daily, hourly even. As the value of the companies that we now partly own go up and down, the value of our investment shares will also go up and down. It’s moving all the time.
This movement is what allows our investment shares to increase in value, making us all happy and joyful inside. But this movement is also what allows our investment shares to decrease in value and make us sad or scared or angry inside.
All that turmoil is exactly what scares many people away from investing.
But the reason we fundamentally feel like we should be investing is because we know that the money in our savings account is never going to grow more than a tiny fraction of a percentage that our bank pays, but our investments have the potential to grow 10 times, 20 times, even 100 times as much, making us huge amounts of money along the way.
Going back to our cookie analogy, if we buy 20 shares of ginger snaps and they lose 50% of their value, our 20 shares instantly become worth 50% less than we paid for them.
This feels horrible!
But, if ginger snaps suddenly increase in value by 50%, then our 20 shares instantly become 50% more valuable.
This feels awesome!
This is exactly how money is made with investing. We buy shares at a certain price, and later when those shares are worth more and selling at a higher price, we have the option to sell our shares at the new higher price and pocket the difference.
With a savings account, we know it will never lose 50% of its value, but we also know our savings account is never going to gain 50% in value either.
A savings account is a great financial tool. We should have some money parked in a nice safe savings account, just hanging out and doing nothing to cover us when life takes a swing at us.
But if we never let any of our money run free in an investment account, we’ll never have the opportunity for those big gains.
Now you understand the fundamental difference between money in a savings account (or under your mattress) versus money being invested.
There is much greater risk involved when we buy investments.
Our Investments make money when the value of the investment increases over time and is worth more than the price we paid for it.
And, unlike our savings account, the price of investments moves around all over the place all the time. It isn’t static. We have to be comfortable with the value of our investment changing on a regular basis.
Now we’re ready to let some of our money run free in an investment account, but that puts us right back at the supermarket.
Even when we reduce the types of investments we’re looking at to just company stocks, there are literally thousands of company stocks to choose from.
How in the world are we supposed to know which cookies are the right ones to buy? Which ones are going to increase in value? Which ones are going to increase the most, the fastest?
Now jump into Part 3 of The Beginner’s Guide to Investing, and let’s see if there’s a logical way to narrow things down to make choosing cookies much easier.