Perspectives: Learning to Invest in a Smart Way
Matt Fellowes shares the fundamentals of how investing works
“Make investing a habit.”
It’s advice you might’ve heard before, and for good reason. Research shows that people with high investment knowledge are more prepared for retirement, and feel less anxious about it. In addition, investing consistently, and a bit out of every paycheck, is a powerful way to earn more money over the long-term than by simply saving up. And that could be brilliant news for your big-picture financial goals and overall financial health.
But what exactly is investing? We (virtually) sat down with Matt Fellowes, Head of United Income from Capital One, to learn the fundamentals on how investing works.
Debunking a Common Misconception
Let’s start by clarifying the difference between investing and saving. Both investing and saving involve setting aside money today to prepare for the future, so it’s understandable that some people mix them up, or think of them as interchangeable. But, investing and saving aren’t exactly the same, and how you approach both can have a big effect on your overall financial picture..
Saving (we’re not talking about stashing cash under your mattress) means putting your money away in a savings account at a bank—one that’s insured by the Federal Deposit Insurance Corporation (FDIC). FDIC insurance guarantees that if something happens to the bank that houses your money, you won’t lose your money (up to $250,000). That means when you save, you’re essentially taking zero risk.
“Savings is a necessary first step to investing and when you save, you’re putting money away in an account that’s earning interest,” says Matt.
When you put your money in a savings account, you typically earn a varying amount of interest. That’s because technically, the bank is paying to borrow that money from you. They use cash flow from customer deposits to loan money to other people (and charge their own interest).
With a savings account, you can withdraw your money any time you want. The bottom line is, savings accounts are considered to be a safe way to have sufficient liquid and long-term reserves.
Investing is the act of allocating money with the expectation of generating a return—a.k.a., income or profit. The spectrum of things you can invest in and earn a return on is wide. You might own individual stocks, bonds or alternative investments, such as starting a business or purchasing real estate in hopes of reselling it later at a higher price.
Fellowes adds, “investing [in stocks and bond markets] is when you take your savings and buy ownership in companies or products that invest on your behalf. With investing, your money has an opportunity to grow at a much faster rate because you’re not just earning interest—you’re owning the future growth and increasing valuation of a firm.”
As the values of your investments go up (or down), the value of your investment account will go up (or down). This is what makes it possible to earn (or lose) money when you invest. The exact amount of risk involved depends on the kinds of investments you have in your portfolio.
“Effectively, investing is a lot more risky than saving, but with all things in life, the more risk you take the more upside you can experience. It’s important to recognize that while you can experience more upside, in some cases, you can experience much more downside,” says Fellowes.
The ability to experience upside and downside depends on a stock’s market price. In ideal circumstances, the company you’ve invested in grows and makes money, and it becomes more valuable overall. Then, because that total value gets spread across all the company’s shares, the market price per share may go up.
For example, let’s say the market price of company X’s stock is $5, and you buy 10 shares of it. The value of your investments is 10 x $5 = $50. But then let’s say company X performs well, and its stock is now selling for $6. You still own 10 shares of it. That means the value of your investments is now 10 x $6 = $60. You only paid $50 originally, so if you were to sell those shares, you’d have $10 more than you started with. That means you’ve earned $10 in returns.
Let’s consider bond returns, which generally pay interest annually to bondholders. If you buy a bond for $1,000 and it pays 3% interest for 10 years, you’d be paid $30 each year for it. At the end of 10years, you’d get your $1,000 back—a total of $300 in interest.
Fellowes explained, “risk and return go hand-in-hand in investing; low risk generally means low expected returns, while higher risks are usually accompanied by higher expected returns. The key is to diversify and be smart about your investments, which is why so many people turn to full-time experts to manage their investments effectively.”
Again, investing is considered riskier than simply saving any additional cash you may have. You should consider your willingness and ability to take on risk.
Investing in a Smart Way
According to the FINRA Investor Education Foundation, 21% of those with high investment knowledge feel anxious when thinking about personal finance, compared to 48% with low investment knowledge. It’s important for people to have access to investment knowledge to feel confident about their financial future. “One of the best ways for people to learn about investing is by example,” Fellowes shared. “I always suggest that parents start investing on behalf of their children and then, as they get older, teach them to contribute for themselves.”
Fellowes also provided 3 key principles for folks just getting started:
Make investments with conviction. 90% of Americans feel anxious about money due to the COVID-19 pandemic. Given the uncertainty of the financial environment, it’s natural to want to back out of investments or play it safe. People ask me all the time, ‘is it smart to invest in an uncertain or volatile market period?’ The short answer is yes. While no one can predict the future, we’ve historically recovered from every former economic downturn. One reason why is that the population has historically grown nearly every year, which means additional consumers are being created that will buy more goods and services in the future. That means today’s companies can sell to more people over time, which can boost their revenue, profits, and valuations over time. This trend has acted as a life preserver for the economy, since it provides long-term buoyancy whenever the economy is struggling. However, there are a lot of nerve-rattling moments underneath that long-term trend, so you have to invest smartly and with conviction to stay invested in difficult times.
Keep a long-term focus. Continuing to invest no matter what’s going on in the market will help get rid of the risky guesswork or overconfidence, make investing a solid habit, and give you the opportunity to grow your net worth steadily over time. You are much better off holding investments for a long period of time, rather than selling or trading them regularly. There are lots of reasons for this, but this is the most basic and fundamental lesson that is too often overlooked by investors.
At United Income from Capital One, our approach to long-term investment management starts with your comfort level with risk. As your finances or priorities change, we modify your investment strategy to reflect these changes. Ultimately, each customer has a personalized investment portfolio that works in tandem with their Personal Risk Score, as income sources and spending needs change over time, and as they get closer to reaching their goals.
Automate your investments. This one is a no-brainer! When things are “out of sight, out of mind,” you don’t have to waffle with the decision of spending or investing your money.
As we live longer and healthier lives than any other point in history, the realization of your potential and financial well-being has never been more important.
This story is part of a 3-part series on how investing works. Stay tuned for additional perspectives on stock market volatility and building for retirement.
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Capital One Financial Corporation offers a full range of investment advisory, banking and lending products and services through its subsidiaries. Investment advisory services and products are offered by United Income, Inc., also known as United Income from Capital One, (collectively, “United Income”) an SEC-registered investment adviser. Banking and lending products and services are offered by Capital One, N.A. and Capital One Bank (USA), N.A., Members FDIC.