The Foundations of Investing in the Stock Market: Part 1
I was having a conversation with Doc G of the What’s Up Next Podcast recently and reminiscing on how HARD I tried in college to understand the whole investing thing. When taking a break from studying bio at the coffee shop, I would pick up the Wall Street Journal and try to learn about investing. Everything seemed so complicated and volatile. Mind you, this was right around 2008 and the stock market crash. I got stuck in analysis paralysis and never got up the nerve to start a Roth IRA and never got started investing. In retrospect, I really should have been reading a personal finance book. I could have gotten all those “On Sale” crash prices! Woulda, coulda, shoulda. In truth, I never felt like I had enough time to study finance.
And that’s the problem really.
Doctors aren’t dumb about money, we just never had enough time to learn about money and investing.
It’s hard to read finance books while learning how to be a good doctor.
I finally feel like I have the basics down.
So, I’m going to break it down, First Aid for Step 1 style. So, this is by no means a comprehensive guide. It is a place to get started.
Why We Should Be Investing
Why should we invest our money instead of stashing cash in our mattress? First, that would be highly uncomfortable. Also, those stuffed money rolls will be worth less every single year: 2-3% less per year on average. That’s deflation, Kyle. How about we put that money to work making us more money while we sleep? Now we’re talking. The stock market has had an average return of 7-10% on average historically. While this does not guarantee future results, the data is good overall so far.
The Power of Compound Interest
The beauty of investing is in compounding interest. With compounding interest, we earn interest on our initial principal AND the interest earned by that money. With simple interest, we only earn interest on our initial principal. With compounding, the interest earns interest.
Being on the other side of compounding interest SUCKS (i.e. student loans). This is why I advocate for paying the student loans off as quickly as possible! Investing is how we make compounding work for us, instead of against us.
Let me break down how compounding works.
Say we put $10,000 in the stock market this year. Let’s assume 10% return yearly and no withdrawals or additional deposits. At one year, our balance will be $11,000.
Here’s the cool part:
At the end of year 2, our balance would be $12,000 with simple interest (adding another 10% of 10,000).
But, with compounding, our balance will grow to $12,100, thanks to our principal and interest earning interest.
In 10 years, we’ll have $20,000 with simple interest OR $25,937.42 by compounding interest.
The growth of our money with compound interest is EXPONENTIAL, not linear. Give it 40 years and our $10,000 will turn into $452,592.56 with compound interest, without us ever contributing another single penny to that initial $10,000. Compare that to simple interest: $50,000 total at 40 years.
Simple Interest Versus Compound Interest
Pretty neat huh?
If we look at the exponential curve, it’s pretty flat initially, but it takes a turn upward fast around year 20.
That’s why we should start investing NOW, rather than later- Time in market is the key to exponential growth. This leads to the common adage-
“Time in market is more important than timing the market.”
You can play with a compound interest calculator here.
Also, the graph above shows us that as long as we are investing to get AVERAGE returns, we’ll do fine. We don’t have to try to win the lottery or discover the next Apple stock in its infancy. All we need to do is invest early and steadily.
Now, the stock market is not a guarantee. The market waxes and wanes. There is no such thing as a free lunch. An important aspect of investing wisely is NOT freaking out and selling when the market drops. As long as we ride out the storm, the market will come back up eventually. If you’re not convinced, read J. L. Collin’s explanation here.
When most doctors finish their training in their 30’s, they are already 10 years behind their peers on the exponential growth curve. My bestie in college was an accounting major. We both studied our butts off in college. He started working right after college. I went to 4 years of med school, then 3 years of residency, then took another 4 years to pay off student loans. When I finished residency, he was so much ahead of me financially! But, watch out, Raj, I’m catching up!
And so can you.
Where do we invest? How do we do it? Look out for Part 2, next week!
Stay Frugal, ya’ll!
Standard Disclaimer: Not meant as individualized financial advice. Based on average historical numbers, results in the future are not guaranteed.