This is the ultimate dummy question and it's probably alot to answer here, but I really don't understand how investing works. I mean, how do you make money from it? All the FIRE people who have retired early and are living off their investments....how does that work?? I opened an iDeCo and a robo-advisor account, but I really want to understand it.
I'm sorry for such a stupid question, but this isn't something I've ever learned about in school or from family (I heard my father lost some money in the stock market, that's about it). I tried to google it, but even searching something like "investment for beginners" still assumes a certain amount of knowledge up front.
How does investing actually WORK?
Re: How does investing actually WORK?
I'm sure there will be some detailed replies, or at least links to detailed replies, but I'll have a quick go.
The basic idea is that you buy something that you hope will make you money. It can do that by generating periodic income, or by increasing in value. If it does both, even better. You take on some risk (of losing your money), in the hope that you'll get more than if you just left the money in the bank.
Examples of investing:
To mitigate the risk of losing too much if a single investment fails, you make a bunch of different investments. That way the risk is spread out across all your investments. This is what investment funds do, which is what you can buy in iDeCo.
What the FIRE movement, and normal retirees, do is buy so many investments that the money they generate is enough to live off. The investments continue to grow, so even by selling some, the income generated doesn't decrease. The catch is that the amount that needs to be invested to achieve this is huge, which is why it normally takes a lifetime. The FIRE movement goes to extremes by saving far higher percentages of their income than average, in order to reach the level of investments required to pay their living expenses earlier.
The basic idea is that you buy something that you hope will make you money. It can do that by generating periodic income, or by increasing in value. If it does both, even better. You take on some risk (of losing your money), in the hope that you'll get more than if you just left the money in the bank.
Examples of investing:
- Buy a house or any other property to rent it out. You make money on the rent, and maybe also when you sell it later. Risks are that you can't find a tenant, or they trash it, or it needs the roof replacing, or the housing market crashes so you can't sell it at a profit, etc.
- Lending people money and charging them interest. This generates you cash until they pay you back. Risk is they don't pay you back . This is what bonds are.
- Buying a part of a business. Like the house, as an owner, you have the right to a share of the profits, and maybe you can also sell your share later for more than you paid. The risks are that the company doesn't make money, loses value so you can't sell your share for profit, or goes under. This is what stocks are.
To mitigate the risk of losing too much if a single investment fails, you make a bunch of different investments. That way the risk is spread out across all your investments. This is what investment funds do, which is what you can buy in iDeCo.
What the FIRE movement, and normal retirees, do is buy so many investments that the money they generate is enough to live off. The investments continue to grow, so even by selling some, the income generated doesn't decrease. The catch is that the amount that needs to be invested to achieve this is huge, which is why it normally takes a lifetime. The FIRE movement goes to extremes by saving far higher percentages of their income than average, in order to reach the level of investments required to pay their living expenses earlier.
Last edited by adamu on Thu Jan 24, 2019 11:38 pm, edited 1 time in total.
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RetireJapan
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Re: How does investing actually WORK?
Can't really improve on that!
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eMaxis Slim Shady
eMaxis Slim Shady
Re: How does investing actually WORK?
Very well explained by adamu.
I'll try to simplify it even further.
Think about it this way, we need money to perform our daily activities such as food, shelter, medicine etc.
Similarly, other people and companies need money to perform their tasks. When you are investing YOUR money, you are basically LENDING it to them. In return, they are paying you an interest or a fixed sum. The risk you hold is that, maybe they are unable to pay you back (many reasons such as death, bankruptcy etc.) in which you do not get your money back.
Ofcourse, this example is not true for all the asset classes, but should give you an idea of how investing works.
Another example: You go to the bank to borrow money to buy a house. The bank is investing their money in you because you are paying them an interest. You could run away, choose not to pay, die etc. and that is the risk which the bank possess.
However the bank minimizes their risk by doing a background check on you, holds collateral, has insurance etc. as safety measures. Similarly, you as an investor should do some research on who or where you want to invest to reduce your risk.
Hope this helps!
I'll try to simplify it even further.
Think about it this way, we need money to perform our daily activities such as food, shelter, medicine etc.
Similarly, other people and companies need money to perform their tasks. When you are investing YOUR money, you are basically LENDING it to them. In return, they are paying you an interest or a fixed sum. The risk you hold is that, maybe they are unable to pay you back (many reasons such as death, bankruptcy etc.) in which you do not get your money back.
Ofcourse, this example is not true for all the asset classes, but should give you an idea of how investing works.
Another example: You go to the bank to borrow money to buy a house. The bank is investing their money in you because you are paying them an interest. You could run away, choose not to pay, die etc. and that is the risk which the bank possess.
However the bank minimizes their risk by doing a background check on you, holds collateral, has insurance etc. as safety measures. Similarly, you as an investor should do some research on who or where you want to invest to reduce your risk.
Hope this helps!
Re: How does investing actually WORK?
Thanks everybody!
I understand about making money when selling off stocks and such, but I dont know about investment dividends. How does that work with iDeCo? Are the dividends re-invested or stuck away somewhere for my retirement? How about with THEO? I signed up for that so I could get started right away, knowing it would take forever for iDeCo to get up and running.
I understand about making money when selling off stocks and such, but I dont know about investment dividends. How does that work with iDeCo? Are the dividends re-invested or stuck away somewhere for my retirement? How about with THEO? I signed up for that so I could get started right away, knowing it would take forever for iDeCo to get up and running.
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RetireJapan
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Re: How does investing actually WORK?
iDeCo is all mutual funds, and they reinvest the dividends (which means you don't get dividend income, but your investments grow faster). THEO does the same.
In a NISA or regular investment account, you would receive the dividends. Some funds allow you to set them up to reinvest them as well. This tends to be more tax-efficient, although some people like to receive dividend income.
In a NISA or regular investment account, you would receive the dividends. Some funds allow you to set them up to reinvest them as well. This tends to be more tax-efficient, although some people like to receive dividend income.
English teacher and writer. RetireJapan founder. Avid reader.
eMaxis Slim Shady
eMaxis Slim Shady
Re: How does investing actually WORK?
Do mutual funds always reinvest the dividends?
And....what is a regular investment account?
And....what is a regular investment account?
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RetireJapan
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Re: How does investing actually WORK?
No, some mutual funds don't pay dividends. Some pay them, but give you the option to choose to reinvest them. And some pay them and don't give you that option.
A regular investment account is taxed, unlike NISA and iDeCo.
English teacher and writer. RetireJapan founder. Avid reader.
eMaxis Slim Shady
eMaxis Slim Shady
Re: How does investing actually WORK?
And...I'm back to being confused again. 
I really want to be good at investing, but it seems impossible!
I really want to be good at investing, but it seems impossible!Re: How does investing actually WORK?
Unless you open an account and start investing just reading theories and getting advice won’t be very helpful.
I kept reading for years and it always seems impossible, always had the assumption that investing was for Wall Street brokers like in the movies and not common people.
The system is build to make it look dreadful.
I would recommend, open an account with SBI, Monex or Rakuten... there is nothing to loose. You don’t have to pay fees just by having the account open and ready.
Next step: invest a small amount $100/ ¥10,000 on an index fund, just to build confidence and prove yourself how easy it is to invest.
I promise you after that things will be much clearer.
You are overthinking it. I personally believe is better to start saving and investing as soon as possible as than to waste precious time on the market by over analyzing everything. As long as you stay away from high fees, single stocks and panic when things seem to go down, you will be fine.
I kept reading for years and it always seems impossible, always had the assumption that investing was for Wall Street brokers like in the movies and not common people.
The system is build to make it look dreadful.
I would recommend, open an account with SBI, Monex or Rakuten... there is nothing to loose. You don’t have to pay fees just by having the account open and ready.
Next step: invest a small amount $100/ ¥10,000 on an index fund, just to build confidence and prove yourself how easy it is to invest.
I promise you after that things will be much clearer.
You are overthinking it. I personally believe is better to start saving and investing as soon as possible as than to waste precious time on the market by over analyzing everything. As long as you stay away from high fees, single stocks and panic when things seem to go down, you will be fine.