Month: April 2022

I am going to go over 6 money and stock market facts that will help you become more financially savy and give you a foundation for becoming a successful investor. These six facts will help you better understand some of the rules of money. Most formal education doesn’t do a great job of teaching us how money works. If you want to do well in any game, you have to understand the rules of the game. Some of the six facts that I am about to share with you might surprise and shock you, so you are definitely going to want to stick with this to the end.

Fact 1, Compound interest is the concept in which your money is interest can generate interest. Einstein described compound interest as the eighth wonder of the world. This graph will show you a little bit of what compound interest can do here if we start with $10,000 in year 1 and we compound at 10% per year we would have more than $67,000 after 20 years. This is because each year the interest from the previous years earns interest. The key to compound interest is time and the rate of compounding. In this graph you can see that a 15% compounding interest rate would turn $10,000 into over $163000 in 20 years. The key to making compound interest work for you is to invest in assets that generate a return. One possibility is stocks. Stocks are small pieces of ownership in companies. They are one form of asset that can help you earn compound interest.

Fact 2, The stock market is not a zero-sum game. More wealth is being continually created in the stock market. There are many examples of zero-sum games like gambling. In gambling one person’s winnings are another person’s losses. Some professions could even be a zero-sum game where the only way you can get a better job is to take somebody else’s job. The total market capitalization of all publicly traded securities worldwide rose from US$2.5 trillion in 1980 to US$93.7 trillion at the end of 2020. As you can see, worldwide wealth continues to grow and is not a zero-sum game. You can be part of this growth if you think strategically about money.

Fact 3, Movements in the stock market reflect movements in company earnings. In fact, increases in the S&P 500 over the last 100 years are highly correlated with increases in earnings in the underlying companies. For example, here you can see that the apple share price corresponds with earnings per share over time. Earnings for the entire S&P 500 have continually gone up over the years, although not in a straight line. The art of stock market investing is the art of picking companies that will have increased future earnings or will be valued fairly in the future.

Fact 4, Value investing is how greats like Warren buffet and Peter Lynch had made billions. Great investors of the past have had a little bit better track record picking value stocks over growth stocks. It is difficult to predict the rate that a company will continue to grow and all fast-growing companies will eventually slow down the growth as they become larger. On the other hand, picking value stocks one tries to find companies that are too cheaply valued today often due to overreactions of bad news. Value investing takes great patients. Value investors will often hold their stocks for many years and are not looking to make a quick buck. Again, all of the most successful investors of all time and typically been value investors. They combined their ability to find cheap stocks with compound interest and overtime this can build a vast fortune. Again it is important to note that value investing is also not a zero-sum game as the stock market continues to build wealth over time and there is more wealth within the stock market today than there ever has been in the history of the world, therefore, odds favor the investor.

Fact 5, Inflation is very high right now this means that your purchasing power is continually being wiped out. You should be really worried about this! Do you know that your money is losing value in the bank? The consumer price index has inflation at 7.9% right now. This means your purchasing power is disappearing quite quickly. Let’s look at this example here. If the inflation rate stays at 7.9%, in 10 years time $10,000 in your bank account would only be worth $4391. This probably worries you and rightfully so. Historically inflation rates have been closer to 2%. This is still a really big deal at 2% inflation ten thousand dollars in 10 years would have the purchasing power of $8170. This means cash is losing money. High inflation is tied to the Fed printing money at an accelerated rate. When the government wants to pay for something they can simply print money to pay for it. This is the root cause of inflation. Imaging if you or I wanted to buy a car and printed money to pay for it! That would be called counterfeiting! Current high inflation is a worldwide phenomenon which has not always been the case in the past.

Fact 6, On top of inflation being really high, bond interest rates are really low. In fact, since the great financial crisis of 2008, real interest rates have been negative. Real interest rates are defined as the nominal interest rate of one-year treasuries minus the inflation rate. On this graph you can see since the great financial crisis of 2008 real interest rates have been negative. After the 2020 stock market crash due to COVID-19, the one-year treasury rate was very close to zero until recently. Historically speaking a person has typically been able to earn money by having money in the bank account. These times since 2008 are really unique times and where you do not gain money by having money in a bank account. The federal funds effective rate has been close to zero since the great financial crisis and now sits at 0.2%. The average money market account may pay something similar. Additionally investing in bonds is not a very attractive alternative either, as bond interest rates are really low and have smaller returns than inflation. Historically portfolios are comprised of 60% stocks and 40% bonds. In these times, 40% holdings in bonds not make quite as much sense as they did in the past.

You guys have worked hard for your savings and don’t want to see your purchasing power eroded by inflation. So, what can you do to preserve your purchasing power? Many experts today suggest investing in value stocks from mature companies that may pay a dividend and are relatively cheap. Gold and other commodities have often done well in times of inflation for preserving your purchasing power but may not provide a real return. Real estate historically has done OK in times of inflation, however, currently real estate is very expensive. Mortgage rates are on the rise this may have the effect of pushing down home prices to a point in the future where they may be attracted for purchase.

In conclusion, money is not safe in the bank as your purchasing power is being eroded quickly. Gaining financial awareness can protect us and our hard-earned purchasing power from being taken away from us. If you like this content, consider subscribing to see more information related to the financial planning. If you have other ideas or points to make, leave them in the comments. Bye.