What is investing? A guide for parents wanting to invest for their kids
What is investing?
In my blogs I suggest that if you are saving for your kids from a young age then you should consider investing those savings. Investing is expected to increase their savings by more than if you put the money in a bank account and it also helps teach kids lessons that are not taught in school. The obvious question that a lot of people then ask is: “What is investing?”
In this blog, I’m going to answer this question so that you can feel confident to invest for yourself and your kids.
Lesson 1 - Investing in a company
Since my kids were young we have been investing their savings. My girls (now 5 and 7) have started to ask me “What is investing?”. To help answer this question I took my girls to McDonalds and said “See those people over there paying at the checkout? As we are investing your savings, some of the money those people are handing over is yours as you own part of McDonalds”. I then took them to the Apple Store and Starbucks and said the same thing.
Investing is owning a piece of a company (or a ‘share’ of the company). The more you invest, the more you own. That’s the very basics of it.
The next question my eldest asks is what happens when the company gets our money?
When you invest, you are giving some of your money to that company. The company uses that money to create more products, hire smart people and is able to expand their business into new countries. By doing this the company can hopefully grow. If the company grows, the value of the company increases. If the value of the company increases, then your money grows as you own part of that now larger company. So when you want to sell your investment, you get more money back than originally put in.
Another way to explain this is that you give a company some seeds (the money you invested), they plant those seeds, with all the other seeds from other people and the company looks after those seeds. After a while those seeds turn into trees and they have a large forest. You own some of those trees which is worth a lot more than the seeds you gave to them so you are better off.
Lesson 2 - Income from investing
As companies make a profit from their business, i.e. make more money than they spend, they use some of this profit to improve their company (more research, paying the staff that did a lot of the hard work a bonus and buying more raw materials so they can sell more goods in the future). The rest of the profit is paid to the owners of the company (shareholders) - this would be you if you invested in them. Most provide this payout to shareholders four times a year and it is called a ‘Dividend’. The dividends you receive vary from company to company and year to year.
If you think of investing like planting a tree, over time that tree will produce seeds (dividends) which you can plant and another tree will grow. This repeated over many years will result in you having a forest.
Lesson 3 - The risks of investing
The above describes the mechanics of investing in a company and how you can make money by investing in companies.
There are also risks with investing. If you give your money to a company and then that company does not do well then the value of that company could fall. If it falls then you will get less money back than that which you started with. We talk about how you can reduce this risk shortly but firstly I want to provide a bit more information on why companies can lose money.
A company can fall in value due to a number of reasons. Below I’ve listed a couple:
a new competitor comes a long and takes away all their customers
the costs of the materials they need to make their products increases
new technology comes along that means no one uses their product any more.
The perceived risks of investing are why a lot of people do not invest. This could mean your kids losing out in terms of how much their savings can grow. I’ve written a blog just on the perceived risk of investing to give you more comfort in this area. Link at the end of this blog.
Knowing which companies will do well and which will do badly is requires a crystal vall (even the professionals get it wrong more often than not). The good news is that you don’t have to choose. You can invest in the entire ‘stock market’, let me explain this in lesson 4 below.
Lesson 4 - Investing in the stock market
The stock market is essentially like Amazon. Instead of buying goods or services from companies, you consider which companies you want to own. You could buy ‘shares’ in Apple or McDonalds. Most countries have their own stock market which have different companies to chose from.
You may have heard of the FTSE 100 in the UK. This is the stock market which covers the 100 largest UK companies (where the public can buy their shares). There are other stock markets as well. Like the FTSE 250, which is the 250 largest companies in the UK. Then there are stock markets in other countries (S&P500 in the US, Nikkei 225 in Japan).
As mentioned above it is possible to invest in the entire stock market in one go so you don’t have to chose an individual company. Essentially you can own a small bit of each company in the stock market. This means that if one company does really badly it does not make a massive difference as you have invested in lots of other companies. On the positive side, if a few companies do really well you’ll own a piece of them and see your investments increase! Essentially you are covering your bases. The value of your investments would therefore be the average performance of all the companies in the stock market (with a greater weight to the performance of the larger companies in the market).
Nowadays you can invest in all major markets around the world in one go to make it super easy to invest in lots of companies and lots of countries. For our girls we invest in a fund which invests in many stock markets around the world in one go. This means we are spreading our investments over 6,000 companies. We just pay into a fund each month and they do it all for us.
Essentially we are planting lots of seeds in different places for our girls to avoid planting in one particular place which could turn out to be a bad place to plant them.
It is still possible for the value of the stock market to fall and your money to be less than the original amount put in. Over the long term, however, the potential upsides are greater than the downsides, especially with interest rates currently at such low levels.
Historically the global stock market has outperformed savings in a bank by around 4-5% p.a. over the long-term. This means that if you started investing £20 per month for your kids from birth to 18, they could have over £4,000 more than in a savings account (that’s nearly double the amount of savings at 18). To see an illustrative example of how much your kids could benefit based on how much you are saving and how old they are, use the calculator on our homepage www.bluetreeblog.com.
Hopefully the above gives you a good idea about what investing is and the confidence to invest for yourself and your kids.
Before you know it you’ll be planting seeds and your kids will get to witness their own Blue Tree forest grow. Remember, most young adults don’t have a single tree, let alone a forest so you’ll be giving your kids a massive advantage in life.
Thanks for reading,
How to save for your kids? (the benefits of investing for your kids)
This blog could change your kid's financial future (reducing the fear of investing)
Recommended book on investing:
'Unshakeable' by Tony Robbins