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We've looked at the importance of generating income and keeping expenses under control. Now, let's get into the second key part of building wealth: making your money work for you. This is what investing is basically about: putting your money to work so that it makes more money for you. We want to get to a point where we get paid to be rich.
What You'll Discover About Investing
Here are some of the things we'll cover in the following lessons:
In Investing, Knowledge is Power
When it comes to playing the money game, knowledge is power - perhaps more so than in any other area of life.
The worst approach to investing looks like this: "I put my money into XYZ because [some guru/a friend at work/uncle Bob] told me to."
Flying blind as an investor will cost you dearly. So let's set out to gain knowledge, starting with the very basics.
In the video, we look at the example of Bob and Jill and the investment deal they strike. This is the very foundation of financial markets and it's important to be able to understand how a stock, a derivative, an ETF or any other investment vehicle ties back to these basic principles.
The stock market is a complex, scaled up, abstract version of Bob investing investing in Jill's business, accessible to billions of market participants.
If we lose sight of the basics, we can easily fall for scams and be taken advantage of. And on that note, the most important question to ask before making an investment is:
"Where Does the Money Come From?"
The idea of any investment is basically: "put your money into this and you'll eventually get more money back."
That's great, but we need to undestand where this extra money comes from. If I buy a stock today for $1,000 and sell it 2 weeks later for $1,100, where do those extra $100 come from?
Why is this important to understand?
Because the hallmark of scams & ponzi schemes is a promise of "guaranteed" investment returns that are too good to be true.
Countless bad financial decisions could be avoided by first asking where the money comes from.
So, Where Does The Money in a Legit Investment Come From?
With that said, where does the money earned in a legitimate investment come from?
In our simple scenario, money comes from:
- Owning a percentage of a business and getting a share of the economic return generated. Jill's business creates something of value that people pay for and Bob gets a return on his investment because he gets a slice of those profits.
- A new investor coming in (with a higher bid). Bob can sell his shares in Jill's business to another investor. And because the business has already matured and is on the path to success, those shares are worth more than Bob originally paid. In this case, Bob is essentially getting paid for taking on more risk than the next investor.
These returns can be categorized as:
- Fundamental returns: you invest in order to gain a share of economic activity.
- Speculative returns: you invest because you believe that the next buyer will pay more.
Upward & Onward
These basics give you some protection against getting immediately wrecked when you start investing.
In the following lessons, let's take a deeper dive.