Investing 101: What Is Investing and Why Do It?

2019-03-18
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Summary

What Is Investing?

Investing is trading money now for the promise of more money later. Most of us earn money by starting companies or working for them (or for the government). But instead of earning money through our own labor, investing earns money through other people's labor.

Suppose a close friend asks you for $10,000 to start a business. The loan is risky:

Why should you give him $10,000 that you worked hard for?

To convince you, your friend might promise to pay you $15,000 in 5 years: your $10,000 plus $5,000 to reward you for your support. Accepting the deal makes you an investor in your friend's business. If it succeeds and your friend keeps his promise, you become $5,000 richer. All you have to do is give up $10,000 for 5 years and maybe never see it again. It's risky, but the great reward might be worth it.

Compare this to working a job, which most of us do. Jobs make us work to earn money. We trade our time — our lives — for dollars. This seems safe compared to investing, but jobs are risky, too:

And jobs exhaust us and stress us out. Even if nothing catastrophic happens, we're still sacrificing our health and lives for money.

In short:

Why Invest?

We could work hard and spend all our money today. Most people do. But eventually we grow too old and weak to work. How will we make money then? Some fortunate elderly people can work easy jobs for a little cash, but even they rarely make as much as they did in their youth.

Most people aren't fortunate enough to reach retirement without incident. We'll probably face several crises: shifting industry prospects, layoffs at work, medical emergencies, etc. How will we eat and pay the bills when our income disappears and our expenses skyrocket?

Investing is the answer. It can help us earn more money than we can through jobs alone. And if we invest enough, we can make all the money we need to live well without working. Investing replaces work. This is why investing for emergencies and retirement is so important: We need to be able to make money without having to work.

"But wait," some ask, "doesn't the government help pay for retirement? Isn't that what Social Security and Medicare are for? Why do I need to invest?" Yes, the government certainly helps, but unless we plan on sitting inside a paid-off home all day and are lucky enough to escape all maladies until death, we'll need a lot more money than the pittance the government offers. And should we count on such programs when so many politicians and average citizens are itching to axe them? No, wise people conclude that the safest plan is funding our own retirements.

Isn't Investing Gambling?

But wait, isn't this the same as gambling? Aren't real estate and the stock market the same as casino games and the lottery?

I'll grant that investing and gambling look similar. They're frustratingly hard to distinguish. But three things separate most forms of investing from most forms of gambling:

  1. Time horizon
  2. Returns
  3. Productive enterprises and societal benefit

Of course some investments are gambling — options trading, gold, and cryptocurrencies like Bitcoin come to mind. Short-term investing (like day trading) and speculative crazes smack of gambling. There are problem investors the same way there are problem gamblers. And investing can't guarantee success. But the three contrasting points I listed above generally hold. Given that, long-term investing is far more likely to succeed than gambling.

Aside: Please remember that the lottery is not an investment. It's designed to tilt the odds in favor of the government. Most who play are poor and dreaming of quick riches. It's a pipe dream! Fortunes are made slowly, not quickly, through diligence and careful planning. If you buy lottery tickets, please save your money and invest or start businesses (or both) instead: That's actually how most people become rich.

A Cliffhanger

Consider this: Many retirement savings articles and popular personal finance personalities say that we can retire comfortably and securely if we invest 15% of our annual income throughout our 40-50-year careers. If that's true, can we retire sooner if we invest more? What if we invest 25%, 50%, or more? We'll explore this possibility in my next post.