Understanding the Basics of Investing
- Jay Smith
- Oct 23
- 4 min read
Updated: 4 hours ago
Investing is a fundamental concept that everyone should grasp. At its core, investing involves sacrificing value in the short term with the expectation of gaining greater value in the long term.
The most common example is money. We lend it out in various forms and receive interest in return.
Investing also includes time. We invest time in education or developing new skills. This can lead to better job opportunities or the ability to fix things around the house through DIY skills acquired over time.
For many, the most impactful form of investing is financial. We allow our capital to work for us while we pursue other interests. Our money generates more money, allowing us to focus on our lives.
Why Do We Invest?
The short answer is profit. The longer answer is security.
Investing protects us from unexpected costs and ensures a secure future without financial worries in our old age.
Investing is about optionality. While money can’t buy happiness, it can provide amazing experiences, the freedom to decline unfulfilling work, and the ability to retire early. It also allows for those impulse purchases we sometimes regret.
Some investors have specific goals in mind, while others may not know their exact needs but understand that having money set aside will be beneficial. If you haven’t thought about your reasons for investing, take a moment to reflect on them.
Common Investment Goals
Here are a few examples of common investment goals:
Property purchase or major renovation
Taking a gap year to travel or explore
Retirement savings or pension contributions
Major purchases or events (car, wedding, etc.)
Funding family education (university, private school, etc.)
Starting a business
Philanthropy or charity work
Building a nest egg or starter investments for children
Each of these goals comes with different time horizons and risk tolerance levels. Consider how long you have to save and how much risk you are willing to take.
The Risks of Investing
As mentioned, investing involves risk.
Generally, the higher the potential return, the greater the risk. This is often linked to volatility. More volatile investments tend to be riskier, but even the safest investments carry some level of risk.
My mother is an example. She copies my trades on eToro but is cautious with her investments. She prefers government bonds and fixed-term savings accounts. While she might earn a guaranteed 4% interest for five years, there are still risks. The currency she invests in could lose value, or inflation could outpace her interest rate, eroding her purchasing power.
On the other hand, I’ve seen some of my investments in start-ups and riskier cryptocurrencies fall to zero. However, by diversifying, I’ve also benefited from some investments that have grown over 2000%.
There is no such thing as a free lunch. If something sounds too good to be true, it probably is. Hidden risks often lurk beneath the surface.
The Power of Compounding Growth
Albert Einstein famously said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
Compounding means that your returns generate additional returns, creating an exponential feedback loop.
For example, if you invest £1000 in company stock and it grows 10% in the first year, you’ll end the year with £1100. A 10% return in year two would bring your total to £1210. In year one, you made £100, and in year two, you made £110. While the numbers may start small, they accelerate quickly. By year 30, you could have made £1586 that year alone.
I used to run these calculations as a teenager, and I was amazed by how impactful the rate of return can be.
With a 10% annual return, £1000 would grow to nearly £17,500 after 30 years.
You might assume that doubling the annual return to 20% would yield £35,000 after 30 years. However, with a 20% annual return, £1000 would grow to approximately £237,500 after 30 years.
These illustrations assume just £1000 invested at the start. If you invested £1000 every year or added £50 a month, the growth would be even more significant:
10% Annual Return:
Adding £1000 each year after the initial investment would generate over £181,000 in total returns.
Adding £50 monthly after the initial investment would generate over £120,000 in total returns.
20% Annual Return:
Adding £1000 each year after the initial investment would generate over £1,419,000 in total returns.
Adding £50 monthly after the initial investment would generate over £1,011,000 in total returns.
This illustrates the true power of compounding returns.
Time in the Market
Many of you may recognize the phrase, “Time in the market beats timing the market.” While the origin of this saying is unclear, it highlights a crucial point in investing.
No one can perfectly time the market. Numerous unknown factors can dramatically influence markets over short timeframes. Data from various brokerages indicates that around 90% of day traders lose money over a 10-year period.
In contrast, if you had invested in the S&P 500 at any point since its inception in the 1920s and held onto your investment, you would have always achieved an annualized return of at least 7.8%. This translates to over 800% in total returns over 30 years.
This doesn’t mean you must invest for that long. It’s reasonable to enjoy some profits along the way, whether for personal goals or emergencies. However, the longer you invest, the more likely you are to see positive returns.
Closing Thoughts
You often hear seasoned investors encourage you to persevere through tough times. So, why not remind you to celebrate the good times as well? I am nearing 10 years as a Popular Investor on eToro, and I have a group of copiers who have been with me for most of that time.
My annualized return since joining eToro is over 26%. If I maintain that level of return for another 18 years, a £1000 investment from year one would grow to £1,025,926 by year 30. If you’re interested in joining me on this journey, it’s never too late to start copying.
Just remember to consider your goals, time horizon, and risk tolerance!
Thank you for taking the time to read my thoughts. I appreciate your support and interest. Feel free to share your investment goals in the comments!
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