Why you NEED to invest
Or how I convinced my college-aged sister-in-law to invest.
Disclaimer: I do not profit from giving out this information in any way.
1. Everything you buy either goes up in value or down in value.
You should spend as much as you can on things that go up in value (e.g. stocks and real estate) and as little as you can on things that go down in value (e.g. everything else).
2. There are two ways to make money
Earned income (from working a job) and investment income (from investing in stocks and real estate). Grow the second one until you don’t need the first. Aside: you’ll need less investment income than earned income because the government taxes investment income far less than earned income.
3. Track your net worth
I would measure your net worth as things you own that go up in value minus your debt. Ex: You own $1,000 in stocks, $0 in real estate, and $20,000 in car debt. Your net worth is -$19,000.
What about the car? If it’s worth $20,000 wouldn’t my net worth be +$1,000? And what about cash? Would $1,000 in a savings account bump my net worth to $2,000? The way I track net worth — no. Your car is a depreciating asset. It’s value is trending towards 0. Your cash is also a depreciating asset. It’s value is also trending towards zero. If you leave depreciating assets (cars, cash — literally everything besides stocks and real estate) in your net worth calculations, you are including things that will have no value over time.
By tracking your net worth this way, it will change your behavior. You will increasingly spend in better ways by establishing what are good and bad purchases.
Should I use cash to buy $1,000 in stocks? Adding $1,000 to my net worth — nice. Should I sign up for $30,000 in debt to buy a $20,000 car? Subtracting $30,000 from my net worth — ouch.
But if I have $20,000 in a savings account, why shouldn’t I count that towards my net worth? Because you are significantly more likely to spend money in a savings account than you are to later invest it. And if you aren’t investing it, then it will go to 0. You can count it towards your net worth when it’s safe from yourself.
4. Understand opportunity cost
So what if I use $1,000 in cash to buy a sofa? My net worth stays the same (because we’re not counting cash). No harm done, right?
Enter opportunity cost. Had you put that $1,000 into stocks or real estate, your net worth would be +$1,000. And what if the stocks you would have bought are worth $1,100 next year? Your net worth would have been +$1,100. Okay, but $1,100 for a sofa you like — and you can’t watch TV on an investment — that may be worth it to you.
Fast forward 40 years and that $1000 could have grown to $30,000. You’ve had to replace the sofa twice. Do you feel like that first sofa was worth $30,000?
The takeaway here is to think about opportunity cost with every purchase you make. If you’re just now graduating college and feel like your retirement number is 40 years from now, then compare your purchases today to what an equivalent investment would be worth 40 years from now.
Given the typical returns of the market over time, with a 40 year window, the math works out to be roughly 20 to 30 times what you’re spending today ($1,000 compounding 7–8% annually). So that $2,000 sofa on sale for only $1,000 today? More like on sale for $20,000-$30,000. All of a sudden it never feels like you’re getting a deal anymore. Good.
Obviously, you still need a sofa — and even if this doesn’t make you walk out with a different one, I find it is always better to be conscious when I make a $30,000 decision.
Ok I’m convinced. Where can I make my first purchase that will go up in value?
So here’s what all the good-hearted experts say to invest in:
- VTSAX (open an account at Vanguard)
- FSKAX (Fidelity’s equivalent to Vanguard’s VTSAX)
- SWTSX (Schwab’s equivalent)
