The
fight or flight response is an interesting phenomenon that surfaces
many times in our life. The way it works is the brain pretty much
figures through physiological response whether to be in the ring and
fight or to leave and run. It is phenomenal how the human body reacts in
so many different ways. It’s a very similar feeling a lot of people can
have while thinking of investing the first time. As a safer approach
you would always hear, banks are your best bet because you can get your
dollars of the same value any time and the price does not go up or down.
Banks definitely are a safer bet because most of them come with FDIC insurance which ensures that the government will step in if the bank is
in trouble. But
what you don't realize is inflation and how it eats into your
capability to buy the same thing with $1 year over year. For example, an
ice cream might cost $1 in 2021 but costs $2 in 2022 and hence the same
dollar has less power to buy than it did in the previous year. As
students, we usually don’t have a lot of money and it’s a safe strategy
to hold on to what you have. But think about the endless possibilities
you can get once you start investing your money early in the stock
market. To clearly think about the possibilities, you need to have a
long view of things and that’s what I have tried to reflect. S&P
500 is a stock market index tracking performance of 500 large companies
that are listed on the US stock exchanges. So assume you have 500
candies in a big box instead of just 1 candy (an individual stock).
Hence you have a larger variety of candies and so lower risk, if you
don't like one then you still have more candies.
Now,
if you look at these graphs which reflect the S&P 500 story from
1981 to the present in the first image, the story from 2017 to the
present 2021 in the second image and the last one from 2020 to 2021.
What do we learn? There are going to be ups and downs in the market but
if you see the overall graphs left to right, the trend has been
constantly going upwards. What the math breaks down to is if you had
invested $1000 in the S&P 500 at the beginning of 1981, you would
have about $77,674.74 at the beginning of 2021, assuming you reinvested
all dividends. This is a return on investment of 7,667.47%,
or 11.50% per year. How does that sound? Am guessing awesome, that is the power of compounding as the Oracle of Omaha, Warren Buffet explains it.
S&P 500 index since 2017 (a 103% increase)
S&P 500 index since 2020 (a 30% increase)
Source: https://g.co/finance/.INX:INDEXSP?window=MAX
Hence
the lesson that I am trying to provide is even though you have only $10
to invest every month, just do it. You can sign up for any brokerage
account online in a few minutes and buy an index fund. There are several
index funds that replicate the S&P 500 index. A number of
brokerages allow you to invest based on dollars and hence you do not
need to buy a complete stock of these funds you can just buy $10 worth
of the fund. Each month if you set aside a little, the power of
compounding and dollar cost averaging will give you enormous returns in
the long run. Dollar-cost averaging is an approach where you keep
investing small amounts of money regardless of the market price, as a
passive strategy you reduce your risk of losing money when you rather
invest lump sum. I believe whatever strategy you follow, go for the long
run and you will reap the benefits.
Similar
to the S&P 500 market index, there are two more famous indexes -
Dow Jones (30 prominent companies listed on stock exchanges in the US)
and the Nasdaq Composite (more focused towards information technology).
The S&P 500 gives you a good balance of Information technology,
Health care, Consumer discretionary, Communication services, Financials,
Industrials, Consumer staples, Utilities, Materials, Real estate and
Energy. Hence going back to the example of candies, basically S&P
500 has all your flavored candies and so you have a lot of options and
lesser risk. That's all for now and I will come back with new ways to be
frugal and rich.
(Disclosure: I invest in the S&P 500 index, please review the Disclaimer section prior to any investments.)
