Area of Study: CEE– Investing; Jumpstart– Investing
People often have trouble understanding how people like Warren Buffett get to where they are now – right at the top of a mountain of money. The simple answer to this question? Compound interest. (Though of course, Buffett’s case is a little more complicated than that.)
Compound interest is essentially interest on interest. Everyone should have it in mind when making financial decisions. You’ll find that $1,000 is worth more today than it will be in 10 years down the road. And that’s not just because of inflation – it’s because of how much money you can have if you invest it today.
For that reason, I recommend that you invest a portion of your income – say $1,000 – each month into an index fund like the S&P 500. If you can start doing this at a young age, you’ll find that it has great benefits. Since the S&P 500 was created, it has gone up some years and down others, but has averaged around a 10 percent return every year.
This means that if you invest $1,000 a month for just over 21 years, you'll probably have a million dollars in the bank.Click To Tweet
And the wonder of compounding will continue if you keep at it. In 40 years, you would probably have nearly $6.5 million in the bank. And only $480,000 of which would be from the money that you put in. The other $6 million would be from the compound interest.
For the most part, this is a much safer strategy than investing in individual stocks. Why? Because individual stocks have a higher level of volatility. Plus, they’re more difficult to track and predict when you don’t have the tools or expertise.
Overall, whatever portion of your income you can set aside each month, you should use it to take advantage of dollar-cost averaging (more on that in another post) and the S&P 500 Index. The more money you put in – and the earlier you start – the better results you’ll get. This process is much more effective than trying to time the stock market or picking stocks that you like.
Article Checklist
Key Words
- stock market
- income
- volatility
- strategy
- return
- S&P 500
- invest
- money
- inflation
- financial decisions
- interest
- compound interest
Questions
1. What is a stock market?
2. What are the names of five of the world’s stock markets? Use the internet as a research tool if need be.
3. What are the risks and rewards of investing in the stock market?
4. What is the S&P 500? Use the internet as a resource.
5. In the article, the phrase interest on interest is mentioned. How does this concept relate to compound interest?
6. How can volatility be both a good thing and a bad thing when buying stock?
7. Why should you only invest money in the stock market that you are willing to lose?
8. Find three companies on the S&P 500 that interest you and list their day range, 52-week range, price-earnings (P/E) ratio, and dividend. Put the data into a spreadsheet, and graph the data to highlight the differences among the companies.
9. Of the three companies that you listed, which would be the best stock to buy and why?
10. Use at least five of the key words listed below the article to write a paragraph starting with “Hassan has always wanted to know more about the stock market.”
