Note: Sezzle U is provided for informational purposes only. Sezzle and its affiliates are not financial advisors; please consult with a financial professional before making any serious financial decisions.
When should you invest?
Most people are so hyper-focused on the finding the “perfect” time to start investing that they forget about the only factor within their control with certainty: the amount of time your investments will have to grow.
There’s a good reason that the most common regret you’ll hear people express about their investments is “I wish I had started earlier” – and that’s because, historically speaking, the earlier you start, the better your returns can be.
There’s one unavoidable and certain truth in investing – when it comes to cash, the value of that same dollar in your pocket decreases every single day. In other words, each year that passes, that same dollar effectively buys less than it did in the year before. For that exact reason, time alone will erode the value of your cash holdings. If you’ve heard people talking about the “time value of money” this is the phenomena that they’re referring to.
The time value of money is the reason that the right time to start investing is right now. It takes time for an investment portfolio to grow – and with each day that passes, you’re leaving money on the table.
The sooner you start, the better. The longer you wait to start investing, the harder it will be to reach your goals.
“Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” – Albert Einstein
Compound interest is the addition of interest to the principal sum, or in other words, interest on interest. In other words, if you have $100 with a growth rate of 10%, at the end of the first month you’ll have $110. And in the second month, your $110 will continue to grow at 10% to $121. The interest you earn is added to your old balance, and together, form the new balance that growth will continue being applied to.
To show you why invest now matters, take this simple example. Two friends invest in the same market, which is growing at 10%.
Maeven starts investing at age 24 and invests $3,000/year for 11 years. When she turns 35, she sees how much her investments have grown, stops investing and leaves the account alone to accrue interest.
Jennifer starts investing at age 35 and invests $3,000/year for 30 years.
At the age of 65, despite Jennifer investing about triple the money that Maeven did, Jennifer ended up retiring with only about half what her friend was able to save. The earlier you start, the more you are able to leverage the power of compound interest.
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.” – Warren Buffett
How should you invest?
Index Funds
An index fund is a portfolio of stocks and/or bonds designed to mirror the structure and performance of a wide swath of a financial market. Instead of buying one share each of the 500 largest companies in the US, you can use an index fund. With an index fund, you can invest in the S&P 500, a stock market index that measures the stock performance of 500 large companies – allowing you to invest in the overall performance of that market (and not just a single stock).
Index funds are a form of passive fund management – instead of a portfolio manager choosing what stocks to invest in and strategizing when to buy and sell, they build a portfolio with securities that mirror a specific index. The biggest advantage for investors is that passive investment requires much lower management fees – meaning you keep more of your hard-earned money.
As an example, let’s say you invest $10,000 and earn an average total return of 7%. If you pay 1% in total fees (advisory & fund expenses) after 30 years, you’ll have a total of ~$835,000 dollars. If you pay 2% in total fees, your investment would build up to be ~$694,000 – meaning you lost $140,000 in fees alone.
Because fees can be taken out as a percentage of the portfolio’s value, the more money you invest and the more successful your portfolio, the more money you’re losing in fees. A 1% as opposed to 0.5% fee may not feel like much over the course of a year, but when saving for retirement, it could be the difference between retiring at age 70 vs. 74.
Aim for the lowest fees possible. It’s one of the biggest advantages when investing in an index fund (which is passively managed).
Other supporters of index funds: Warren Buffet, Tony Robbins and Charles Schwab.
Pros of Index Funds:
Low Risk & Steady Growth. Index funds are inherently diversified, given the amount of stocks they cover and represent. That diversification helps protect your investment against the wild fluctuations that can happen in particular stocks or sectors of the market.
Low Fees. Index funds have lower fees than non-index funds. So when a non-index fund outperforms an index fund, it must outperform by an extra margin to generate returns to overcome the fees it charges.
Cons of Index Funds:
No Big Gains. The diversification and stability you gain from index funds comes at the expense of taking an advantage of a stock’s massive gain. If one stock in the S&P 500 doubles in value, that has a small affect on an index fund with 499 other companies, as opposed to just buying a share of that company.
Lack of Flexibility. If an index’s returns are declining strongly, an index fund manager has very limited options to minimize those losses since as an example with the S&P 500, you’re investing in an entire market.
Dividend-Paying Stocks
For every share of dividend stock you own, you are paid a portion of the company’s profits – as an owner of a (very) small piece of the company, you are entitled to receive payment (either in the form of cash or additional stock) for your portions of the profit the company generates. Your share of the companies’ earnings, called “dividends,” are usually paid quarterly.
If a company has a $0.25 quarterly dividend, and you own 100 shares of that company, you will receive a payment of $25. If that’s consistent across the remaining three quarters of the year, you would’ve earned a total of $100 that year, just for owning those shares.
Pros of Dividend-Paying Stocks:
They generate passive Income. Dividend investing provides a steady source of income, and many of the companies that pay dividends are well-known and established (Ex: IBM, Verizon, UPS) Historically, most dividend-paying companies increase their dividends over-time to keep up with inflation and often provide returns similar to the market with much less volatility.
Take Advantage of Compounding. You can use your quarterly dividend earnings to purchase additional shares of company stock. Effectively, your earnings will earn more money for you since each additional dividend stock you buy will earn its own regular dividend payout.
Ability to Profit Twice. When you buy a typical non-dividend paying share, you only make money if the share price goes up. With dividend stocks, you have two ways two make money: when the share price rises and with your dividend payments. Meaning that as you hold shares, you’re able to share in the company profits while still owning your investment.
Cons of Dividend-Paying Stocks:
Potential Dividend Policy Changes. Nothing prevents a company from changing its dividend policy – keep in mind that when dividend payments are reduced or eliminated, the stock price is usually affected as well.
Dividends Are Taxed Twice. As a shareholder, you pay taxes on your dividends twice – first as owners in the company, and second as individuals, who pay income taxes on their own personal dividend earnings.
Real Estate Rental
You own a piece of property/land – an apartment, townhouse, home, etc. – and charge rent for use of that property. As an example (ignoring taxes to keep things simple), if you own a 4-bedroom house, but only use one of those bedrooms – you can choose to rent the three remaining bedrooms out at $1000/month each. If your mortgage/expenses total $3000/month, you’re effectively able to own property and live on that land virtually free of cost, since you’re using the rent you collect to pay off your housing expenses.
Now that a significant part of your income can be saved as a result of rent you charge, you can use those savings to buy more property. And if you own a second property with the same size/cost/rent, you’ll have an investment that generates $1000/month (after mortgage/expenses) – giving you an extra $12,000/year and $120,000 across a decade.
Pros
Real estate generates consistent cash flow. There are few investments that will give you such a constant, predictable source of cash. Since many leases are signed for 12-months, as a landowner, you’re virtually guaranteed a dependable source of income – remember also that in most cases, as property values will steadily increase over time, so do rent prices.
You can leverage tax breaks. You can deduct most of the out-of-pocket expenses related to managing your property so there’s minimal costs for you – mortgage interest payments, insurance, property tax, maintenance, repairs etc.
Cons
Changes to the Law. Not only do you have to follow current federal laws (Landlord-Tenant, Fair Housing Act, etc.) and state laws (rent control/regulations), there is risk that these laws can change. Laws can determine the number of people that can live on your property, how much you can charge, housing/safety standards, and there are legal and financial consequences it’s determined you’re not following them.
Risk and Liability. Renting property opens up the possibility that tenants will damage your property, not including regular maintenance to keep the living standards according to code. Tenants may not pay rent on time, and you’re legally responsible for their well-being, so they can also pursue legal action against you if they get injured on your property or if you don’t follow tenant-landlord laws.
Real Estate Investment Trust (REIT)
A REIT is a company that owns, operates, and finance income-generating real estate (apartment complexes, data centers, hotels, etc.) A REIT combines the capital of numerous investors so a single individual is able to earn dividends without having to buy, manage, or finance real estate properties themselves. This effectively gives a singular person the ability to invest in real estate without the need for a large sum of capital.
Pros
Steady, High Dividend Yields. REITs are required to pay 90% of taxable income to shareholders, meaning you can expect a stable, annual dividend. In addition to that, REIT total return performance for the last 20 years has outperformed the S&P 500 Index, other indices, and the rate of inflation.
Highly Liquid Asset. When you own a share of a REIT, that one share effectively means you own part of multiple properties. Most REITS are publicly traded like stocks, which makes them a very liquid asset (unlike physical real investments such as a house) so you have the ability to exchange it for cash quickly.
Cons
Slower Growth. A REIT may grow slowly because by law it must distribute 90% of if it’s profits to its investors. Since there’s only 10% left, it can only buy a limited number of new properties.
Limited Diversification. Most REITs specialize in a particular area of real estate (apartment buildings, commercial office spaces, shopping malls, etc.) – so to diversify, you’ll need to put money into multiple REITs to have different types of properties in your portfolio.
Peer to Peer Lending (P2P)
P2P lending enables a person to obtain a loan directly from another person, eliminating the need for a financial institution (such as a bank). P2P lending websites connect borrowers to investors and determine the interest rates and transaction terms. Lenders are able to achieve higher returns than a typical bank savings account, and borrowers can seek a loan with a better interest rate than banks can offer.
Pros
Access to Higher Returns. P2P lending can potentially give you access to significantly higher returns than index funds, REITs, and dividend stocks. The higher risk justifies a higher expected return. Keep in mind you can select how much risk you’d like to take, since you can see the risk rating of each potential borrower you’d be loaning to.
Guaranteed Monthly Income. Unlike a bond, index fund, or REIT where dividends/payments are given to you quarterly basis at best, P2P loans mean you’ll likely receive payments every month.
Diversification of Risk. P2P platforms let you distribute your capital across multiple loans – in other words, you can spread $1000 across 10 separate loans, so if one loan defaults, your potential loss is only $100.
Cons
Credit Risk. Many borrowers that apply for P2P loans have low credit ratings, hence why they’re unable to obtain a standard loan from a bank. While P2P lending can yield higher returns, this comes at the cost of taking on higher risk.
No insurance/government protection. The government provides zero insurance and no form of protection to the lenders in case the borrow does not repay the loan.
