🎙 Investing in the stock market is a great way to make passive income and build your wealth, even for beginners and even if you only have a little bit of money to invest. But it’s easy to lose a lot of money if you don’t know what you’re doing and you make a bad decision. 🤔
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Hello, friends! And welcome back to Girl on FIRE, the financial independence podcast for independent women.
My name is Priya, I’m a Chartered Accountant, an analyst and the creator of Paper Money Co.
I’m also a fierce financial feminist and the host of this podcast. I believe that a woman who is in control of her money, is in control of her life.
Last week, in part 1, we started talking about what stocks are, how to make money from them and what the some of the main benefits of investing in the stock market are.
This week, in part 2, we’re going to address some of the biggest risks of investing in the stock market.
Now, I’m not sharing that information to scare you or give you any more fear about investing.
I’m sharing that knowledge because there are risks involved - I can’t change that. But understanding those risks will help you avoid them.
And we’re also going to be talking about how much you actually need to start investing in the stock market today as well.
But before we really get into it, I just wanted to let you know I’ve put together an Investing Starter Guide which you can get for free on my website, papermoneyco.com.
It walks you through the steps you need to take to get yourself and your finances ready for investing.
It covers budgeting, emergency funds, managing your credit and gives you a clear step by step checklist to get ready for investing. So, I highly recommend you go and check that out.
So, let’s dive in and start with the scary stuff, the risks.
What are the risks of investing in the stock market?
Now, there are a number of reasons and a number of ways you could lose money when investing in the stock market.
And it’s something that a lot of people are really afraid of and a risk they just don’t want to take.
If that sounds like you, then please remember that this is a judgement free zone. There’s no judgement here.
I was super afraid of the risk of losing money for the longest time. And even though I had educated myself on how the stock market works, I was still afraid.
I had learned what the risks were and how to mitigate them. And I knew logically that it was a great way to make some money and build some wealth.
I mean, I studied business and finance and economics. I knew the theory and I understood the logic.
But when we’re afraid, we aren’t always thinking logically. It’s hard to look past that fear. And it’s even harder to do something that we’re still afraid of.
So, it took me a long time to really get deep into investing in the stock market. And it sucks, because I know that if I had overcome my fear earlier, I would probably already be a millionaire.
But that’s not what happened, so here we are. And that doesn’t mean I’ve missed my opportunity altogether. It just means that I have some catching up to do.
So, if you’ve been frozen in fear when it comes to investing like I was, then don’t worry. We’re going to get you investing in no time.
The first step is to learn, and that’s exactly what you’re doing by listening to Girl on FIRE.
Timing the market or day trading
Okay, so let’s talk about risks. One of the biggest risks that I see with stock market investing is that people try to time the market.
And this is a huge thing. So, earlier we talked about one of the ways to make money with stocks being capital gains.
So, buying at a certain price and selling at a higher price. Now, when people try to time the market, they’re trying to buy low and sell high in order to make money.
They’re trying to “time” their trades so that they can make money when the stock price moves in their favour and bail before the stock price drops.
Now, here’s why that’s so risky: stock prices move all over the place in the short term. Yes, the market moves in an upward trend over the long term, but it’s not a straight line.
It’s a zig zag. So, prices are going up and down, up and down all day. And when you’re trying to time the market, you’re essentially relying on how quickly you can put in a buy or sell trade.
And this becomes very risky. It’s very easy to lose a lot of money this way. Not only that, but you waste a lot of time glued to a screen hitting refresh and you’re not really growing your wealth or living your life.
Now, if you were researching companies and choosing to invest in stocks because the company was set up to grow and prosper — that’s another story altogether.
That’s a smarter way of investing and we’ll talk about that in future episodes.
Something to note is that timing the market is also often called day trading, and I’m sure you’ve seen that out in the internet wilderness.
And it’s called day trading because these speculators are buying and then selling securities on the same day.
And if you’ve ever heard myths that the stock market is like gambling, this is why. They’re called speculators for a reason, it’s all speculation!
You’re essentially buying something and hoping that the price goes up and that you can sell it at it’s peak before it declines again.
Income is not guaranteed
Moving on, another risk of investing in the stock market is that your income isn’t guaranteed.
Now, think back to 2020 for a minute at the height of the COVID pandemic when the markets crashed in March.
A lot of investors were seeing their capital gains disappear when the market crashed and stock prices fell.
Now, remember what I said earlier, when you hold the security, your gain or loss is unrealised. But when you sell it, that’s when it becomes real.
So, investors who held on to their stock and didn’t sell will recover their wealth. But in the mean time, they don’t have any capital gains to cash in and use as income.
Not only that, but a lot of companies either stopped paying dividends or paid a much lower dividend. And that’s because they weren’t able to generate as much profit.
So, if you were relying on those dividends as your income — guess what? Your income just disappeared.
Some companies keep paying consistent dividends even when their profits take a hit. But it’s still up to the company to decide whether they pay the dividends or not,
So, your income isn’t guaranteed. And if you were relying on that income to fund your lifestyle, that’s one of the situations where you may have to take on some part time work or dip into your emergency fund.
And if you do use your emergency fund, firstly, don’t feel bad — that’s why it’s there. But you’ll have to replenish it as soon as you can.
Next, we have economic risk. Now, this is the risk that the economy can take a downturn or even head straight into recession.
This isn’t something that happens overnight, but it does happen. Economies are a cyclical beast and recessions always come around, but they’re also always followed by a boom.
Now, economic risk is going to be a bigger deal for older investors who are closer to retirement. You might not have enough time to wait for the market to recover before you retire.
And in the worst case scenario, you’d be going back to work for a little while longer.
For younger investors, it’s a different situation. You have time to wait for the market to recover.
I like to think of recessions as a stock market fire sale - a lot of investors do. Because when the economy isn’t doing well, stock prices fall.
Which means that they’re on sale. Because we can buy those shares for a price that’s below what they’re worth. And when the price goes up, our wealth increases as we earn capital gains.
Market value risk
Then, there’s market value risk. This is something that happens because of speculation. It happens when the market goes crazy chasing the next hot stock.
And that moves all the focus to that stock and the price of that stock goes up and up and up. So, let’s say that company ABC is the next hot stock.
And speculators are a lot like seagulls chasing a chip at the beach. I’m sure you know what I’m talking about.
They flock towards it, they pounce on it.
But let’s say you don’t own stock in company ABC. You own stock in company XYZ instead. Your investment in company XYZ gets ignored.
Nobody wants it, everyone wants to make money off company ABC. And if there’s no demand for company XYZ’s stock, then the price won’t go up.
Not only that but other investors in company XYZ might decide they want a piece of the action. They sell their stock in XYZ to go after the hot stocks.
This increases the supply of company XYZ’s stock on the market which makes the price go down. Because there’s no demand and an increased supply.
So, this is a sucky thing but it’s something you really need to be aware of. Girls on FIRE are smart investors who pick stocks based on company performance instead of day trading.
But that doesn’t mean all investors are making solid financial choices. Some of them really are like a pack of seagulls coming after your chips.
And the last risk I wanted to talk about today is inflationary risk. Now, this one is a little bit different when it comes to investing in stocks.
We talked a little bit about inflation in episode 2. Inflation is the rise in prices and the decline in purchasing power over time. Think of it as decaying money.
So, $100 today will buy you $100 worth of stuff. But in order to buy that same stuff 30 years from now, you’ll need more money, maybe $120.
I’ll do a whole episode on inflation in the future but for now what you need to know is that it eats away at your money.
Over time, your money becomes worth less and less and it’s purchasing power declines.
Okay, so inflationary risk isn’t necessarily a risk of losing money on the stock market. It’s the risk that inflation can increase, which means that your money is worth less.
So, the overall returns you make get partially eaten up by inflation.
Now, this will become super dangerous if you’re being super conservative and your returns are so low that they can’t keep up with inflation.
In that case, you would be losing money. So, that’s something to be mindful of.
This is also the danger of keeping your money locked up tight in savings. If the interest rate you earn on your savings is lower than inflation, then your money is decaying.
How can you start investing in the stock market?
Okay, so now that we’ve gone through what stocks are, how they work and the risks and benefits of investing in them, let’s talk about how to actually invest in stocks.
But before we continue I need to ask you, my Girls on FIRE for a favour. I want you to pause this episode for a minute and head over to Apple Podcasts to leave a rating and a review.
Reviews for this podcast are super important. They help other people find us and it also really helps me determine whether you’re getting any value from these episodes and how I can make them even better.
It’ll only take you a couple of minutes but it’s really the best way to support this show and it’s totally free too.
First, you need to figure out how much money you have available to invest. Now, that will partially depend on how much it costs to make the investment and any minimum investment amounts you need to reach.
But apart from that, what you need to do is sit down and take a look at your budget. Where do you have money that you can funnel towards investing? Where can you make cuts to find more money to invest?
Or maybe you’ve already got some money chilling in savings accounts that aren’t being used. You could invest some of that but a word of warning here — do not under any circumstances invest your emergency fund.
You can’t risk losing that money and you might need it at a moment’s notice so don’t invest that.
Next, stocks are bought and sold on the stock exchange through a broker. They execute the trades with your money and using your instructions.
So, first you need to find a broker that suits your needs. In episode 3, I went through the 7 key things to look for when choosing a broker, so I recommend you go and check that out.
The most important thing to note is that brokers execute trades with your money. So, if you don’t 100% trust them with your money, then don’t let them touch it.
So, once you know how much money you have to invest and you’ve chosen a broker, it’s time to choose what stocks you’re going to buy.
Now, this is not as easy as it sounds. In order to make a well informed decision, you really have to do your research when you’re picking stocks.
This is probably one of the biggest downsides of investing in individual stocks. And if you don’t know what you’re doing, it’s very easy to make a bad choice and lose a lot of money.
Don’t just listen to people on the internet. You need to actually research companies, read their financial statements and decide whether or not they fit with your investing strategy.
Now to be clear — whatever you decide to invest in, it’s super important that you’re diversified. We talked about diversification a bit last week.
It’s the idea of not putting all your eggs in one basket. Don’t put all your money in one company.
Now, diversification looks different for every investor depending on your goals and your investing strategy.
But it’ll involve investing in different companies of different sizes and in different industries.
Now, an easy way to instantly diversify your investments in the stock market is by investing in ETFs, which is what I personally choose to invest in.
We’ll be taking a deep dive into ETFs in next weeks’ episode.
How much money do you need to start investing in the stock market?
When it comes to how much money you need to be able to start investing in stocks, it’s going to depend on what the costs are.
Now, this is something we went through in episode 4 - we went through a few different brokerage options in Australia and what the associated costs are.
So, any money you have in excess of those fees can be invested.
It’s also important to note that some brokers also require a minimum initial investment amount.
I personally use SelfWealth for trading. They offer CHESS sponsored trades for a flat fee of $9.50 per trade with no commissions and no minimum investment amounts.
We talked about CHESS sponsored trades in episode 3. I went through a few key things you need to look out for when choosing a broker.
So, if you’re thinking about investing in stocks, I highly recommend you check out episodes 3 and 4 as well before you get started.
But with no minimum amount and $9.50 per trade, you can get started investing in the stock market with as little as $100 or even less.
How does investing in stocks impact your taxes?
Before I wrap up this episode, I just want to make a really quick note on how investing in stocks impacts your taxes.
So, with stocks, you can earn a capital gain or a dividend. When you earn a capital gain, you’ll pay capital gains taxes on it.
In Australia, you’ll pay taxes on both capital gains and dividends at your marginal tax rate, and you can claim an offset for capital losses.
For my listeners in the US, I’m not super familiar with your tax system, but I believe it’s a similar situation.
If you want to learn more about it, just email me at firstname.lastname@example.org and I’ll see if I can get a US tax expert as a guest on the show.
Next weeks’ episode
And that’s all I have for you Girls on FIRE today!
My challenge for you this week is to head to papermoneyco.com and get your copy of my Investing Starter Guide.
It’s totally free, you just need to enter in your email address and I’ll send it to you. And then I want you to start working through it.
It’ll give you a plan to follow, step-by-step to get ready to start investing and building real wealth.
On next weeks’ episode we’re going to taking a deep dive into ETFs — what they are, how they work and how they can help you reach your financial goals.
They’re the ultimate lazy persons’ path to financial independence and they’re what I personally choose to invest in.
It’s going to be a super interesting episode so you’re definitely not going to want to miss it.