Guide to long term investing -- what is compound interest, an index fund & an etf?
Introduction
In order to even be interested in web3, I think a good chunk of it comes from having a traditional finance background (TradFi). This means your average investment strategies are the S&P 500, index funds, ETFs, etc...
Once you have dabbled into tradFi, will then web3 & crypto be a curiosity of yours (not 100% of the time). Therefore in this lesson, we'll do a quick rundown of what compound interest, index funds, and etfs are. Basically a guide to long-term investing (20+ years).
Lesson Overview
- Understanding compound interest
- How to buy Index funds
- Smashing the like button (sharing it with your friends)
Compound Interest
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it” — Albert Einstein, probably, jk it is
Compound interest is almost the same as regular interest but it’s includes what was there previously. For example, If we started with $100 and let's say the money magically grew 10% every year:
Year 1: 10% of $100 is $10. Add that $10 onto $100 making it $110.
Year 2: Do the same thing again, 10% of $110 is $11. $110 + $11 = $121
Year 3: And again 10% of $121, and it continues…
As time goes on, that 10% of $x adds up and is therefore compounding making whatever money you put in worth a lot more than a 0% interest account (your average chase or wells fargo savings account are like 0.001%). In the U.S stock market, many people "magically" make 10% of their money every year through buying index funds. Given it's on a 20 year time-period, meaning the person investing will on average make 10% each year of their money if they just buy and hold for the next 20 years.
So just to re-cap on the previous example, with a initial deposit of $100 and an earning of 10% on average
Year 1: $10 increase
Year 2: $11 increase
Year 3: $12.10 increase
This exponential growth is also known as compound interest. If there were no exponential growth, we would for example only see a $10 increase every year.
Fun fact: On Year 30, it would be a $158 increase every year! This may not seem much but remember, we’ve only put in $100 and never touched it again. Imagine how much this account would be making if we were to add more money every single month for the next 30 years
Why this happens is because the yearly 10% increase is on the balance you have, not the initial money you put in. So as time goes on, your account balance for that year increases by 10%, and so if there’s more money in your account, then the more money you would be making. Compound interest is seeing a x² line instead of a linear line of your account balance.
Index Fund / ETF
So where do I find a company that earns 10% every year? That’s where Index funds and ETFs come into play. Index funds and ETFs are different things but they behave pretty similar. Note: Index funds and ETFs are just names, just like a stock is called a stock.
Companies will issue stocks for people to buy, sell, and own. And if the company’s stock price goes up, then so does the stock that you bought.
An index fund is a pile of stocks pooled together. Many people shy away from just buying individual stocks since companies are kind of risky. Who knows what the company will be doing in 30 years, and so the safest bet is to just buy a whole bunch of them all at once.
There's a quote that i lowkey might've made up saying, "all giants fall one day"
It’s better to invest in a whole bunch of stocks so if one does fail then you still have the others to make up for the loss. Good index funds usually track a good amount of companies and it usually autoamtically rotates companies that are performing good or bad. So in reality, a good index fund will not have a company in the pool if it’s staggering / failing. It gets rotated out for a better or uprising company.
An ETF is basically the same thing as an index fund, except the way you buy it is similar to a stock and it also requires less money to start —- a lot more beginner friendly.
(there’s also a thing called a mutual fund which is the exact same concept of an index fund except it’s a human investor — (forgot to tell you but an index fund is a pile of stocks picked by a math equation). Most people go with an index fund because humans can be emotional; A couple of wrong decisions and your retirement fund is gone lol).
Where to buy?
You can buy these Index Funds and ETFs on Vanguard, Fidelity, TD Ameritrade, Charles Shwab, Robinhood, etc… You can also buy regular stocks on these investment platforms.
I would recommend Vanguard or Fidelity. They’re pretty reputable imo. What makes people choose and decide is nowadays are because of a company's customer service, UI/UX, and ethicality of the company.
Assignment
Try it out! Feel free to just add $10 into an account and see how it goes. There’s a saying that "the best time to start was when you first heard about it, the second best time to start is now.”
Videos to watch step by step on buying your first ETF / setting your account:
- How to set up Vanguard Account — https://youtu.be/k04imamw5QE?si=aX4xorOc8fBH4POh (4:58 minutes long)
- How to buy VTI — https://youtu.be/1g9GPevL-rg?si=bzF7wQZiugm4dt_m (3:38 minutes long)
General advice when creating the account and buying Index funds & ETFs:
- Select individual brokerage account / general savings (unless you want make a Roth IRA for retirement)
- Expense Ratio, generally the lower the better because this is the fee you have to pay every year for the person to manage the portfolio / all the stocks in the pool. VTI for example is pretty low and is only 0.03% meaning of $100, you’re paying 3 cents a year in fees. You can also buy VOO which is an index fund but it needs an initial deposit of $3,000 — which is why I listed VTI in this post since it has no minimum requirements
- Please also do your own research, reddit and youtube is a great place to have your questions answered! & Now chatgpt is amazing for learning
Also not saying you should pour your life savings into index funds & etfs, since you may be looking into buying a house in the short term or need money for school — every circumstance is different, but this was more of an educational / do it if you got money laying around making nada. Keep in mind that index funds can also be risky, because you’re betting on the stock market to continue to rise in whatever time frame. But looking in the past, we can see that index funds have managed to outperform mostly every stock since the it was created. If you know you’re not touching your S&P 500 index funds on a 20+ year time frame — then you should be alright ;)
If you’re still not convinced: It’s why pensions are no longer a thing, and why most companies offer 401Ks as retirement plans that invests into S&P 500 index funds.
- Look into watching what an S&P 500 index fund is
- Again, how to setup your vanguard account + general advice I said above. Super biased of me but dabble into crypto / bitcoin. It’s super risky but watch a video on what bitcoin is about and maybe it can change your mind.
- Fact check my work — if there’s anything you find strange or need clarity on, use chatgpt! Everything above is not finance advice