If you are opening a brokerage account, there are a few key facts you should understand first. Understanding these points can help you to be a better investor and maximize the size of your balance over time.
Here’s what you need to know.
1. Compound growth can help you build wealth if you start early
The first key thing to know is that the earlier you begin investing, the more wealth you can build virtually effortlessly. That’s because of something called compound growth. See, when you invest and earn returns, you get to reinvest that extra money.
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Once your returns have been used to buy investments, your money is making money for you with no extra effort required on your part. Since you have a bigger account balance, you can earn even more going forward. Then all that extra money will be reinvested, too. And this makes a huge difference. Just check out the table below to see the impact of investing $1,000 a year for 10 years versus 20 years versus 30 years, assuming a 10% average rate of return.
Data source: Author’s calculations.
As you can see, although you’ve invested only $10,000, $20,000, or $30,000 total, the amount of profit you end up with becomes very impressive over time thanks to all of your returns being reinvested. So even if you aren’t starting with a ton of money, the sooner you begin transferring some funds from your checking account to your brokerage account, the better off you’ll be.
2. Investment fees can eat away returns
It’s also really important to consider the investment fees that you’re paying as you choose which assets to buy. That’s because fees eat away at those returns over time. And when your earned returns are lower, you significantly reduce the power of that compound growth mentioned above.
Just take a look at the table below to see how different your account balance would be depending on the fees you pay if you invested $10,000 over a 20-year period and earned a 10% average annual return.
|Return on investment
Data source: Author’s calculations.
As you can see, paying high fees really impacts the money you end up with in the end. Look for low-cost ETFs that have very minimal fees to avoid losing a good portion of the money you should end up with.
3. Long-term investors do better
When you invest, you can choose to buy and sell assets frequently or to buy assets you believe in and stick to them for the long haul. One approach has been clearly proved to be better than others.
In fact, one study found that during a period where average market returns were 17.9%, those who traded the most earned just 11.4%. Among those who day trade or hold assets for a very short time in hopes of making a quick profit, anecdotal evidence suggests 95% end up losing money.
Timing the market perfectly rarely works well since we cannot predict the future. So don’t try. If you buy ETFs that track the performance of the market, you can hold onto them forever — which is famed investor Warren Buffett’s favorite holding period.
4. You can get into the market without understanding stocks by investing in ETFs
Finally, the last thing to know is that you really don’t have to know much before you start investing. You don’t have to, and probably shouldn’t, buy stock shares in individual companies without a lot of advanced knowledge. Instead, you can buy ETFs (exchange-traded funds).
ETFs act kind of like mutual funds but are traded like stocks. All of the money in the fund is pooled to buy a bunch of different investments. Usually, the fund aims to mimic the composition of some financial index, like the S&P 500 (an index of around 500 large U.S. companies). Fees are pretty low since no active management is required, and you get instant diversification when you buy them.
Most brokerage firms have screeners that make finding the right ETF easy. You can buy funds that track the entire market, the S&P 500, or subsets of the market like small or large companies. Just check with your brokerage firm’s tools to find out your options. For most beginners, tracking the market or the S&P 500 is usually the way to go.
Now you know pretty much everything required to be a successful investor — so get that brokerage account open and jump in.
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