Compound interest. The 8th wonder of the world.

Do you know the power of compound interest in its entirety?

It’s the greatest thing in the world…when it’s working for you.

When it’s working against you, it can be one of the most devastating things in the world. A catastrophe, really.

I’m just going to take a minute or two to show you the amazing power of compound interest. Then I’ll let you decide if you would rather it work for you or against you.

Here it is. Compound interest. The good and the bad…

Why Compound Interest is Powerful

Compound interest may be more powerful than you think. If you don’t understand exactly how it works, it’s helpful to figure it out. And you came to the right place, because I’m about to explain how it works…both for you and against you.

According to some recent polls, most Americans don’t actually understand how compound interest works.

Many people think that if you have $100,000 and you get a 6% annual return, compounded over 30 years, you’re left with…$106,000. Not quite. It would actually be over half a million dollars. Crazy, right? That’s compound interest for you.

So what happens exactly?

Interest generally compounds annually, so that means you earn 6% on your principle. Keeping with the above example, the first year your principle is $100,000, but at the end of that year, you earn 6%. So that means the second year you’ll be earning 6% on $106,000. Making sense yet?

Of course, this is an oversimplified example and it’s next to impossible to find a 6% return on your investment that stays at exactly 6% for 30 years, but it does make it a whole lot easier to explain. Got the idea?

Here are a few ways compound interest can be your best friend:

• Investing – Just like in the above example, compound interest, over time, can lead to extraordinary results. You continue to earn interest on your money and it continues to grow as it compounds. That’s why a one-time contribution of $100,000 could easily grow to several times that over your life span.
• Early Debt Reduction – I’m about to explain how compound interest can be your worst enemy when you’re in debt, but you can actually take advantage of it with your debt too! By paying extra on your loans, early-on in the term, you will reduce your interest bill by a ton. In fact, with your mortgage, making a few extra payments in the beginning can knock years off the length of the loan. Don’t believe me? Read this.

If you prefer more of a mathematical explanation, here is the formula, with a worked example:

The formula for annual compound interest is A = P (1 + r/n) ^ nt:

A = the future value of the investment/loan, including interest
P = the principal investment amount (the initial deposit or loan amount)
r = the annual interest rate (decimal)
n = the number of times that interest is compounded per year
t = the number of years the money is invested or borrowed for

Compound Interest as an Enemy

Just like compound interest works for you, it can work against you (which means it’s work for somebody else).

When you’re investing, it’s nice to know that you’re interest compounds annually, when you’re in debt, it’s terrible to know that your interest compounds annually. This means that you pay your APR (Annual Percentage Rate) every year, based on the remaining balance. So if you owe $10,000 on your car and you have a 14% interest rate, you pay 14% of $10,000 the first year. After that you pay 14% of the remaining balance each year. Of course that amount is divided over your monthly payments.

This is why, if you have ever looked at your mortgage annuitization schedule, you may have noticed that during the first few years, the majority of your payment is going to interest. That’s terrible if you’re paying your regular minimum payment, but if you pay extra, you can take a huge chunk out during the early years.

Here are a few ways compound interest can be your worst enemy:

• Mortgage – The typical mortgage in the United States is 30 years! That means that even a low interest rate of 2% or 3% can be well over $100,000 paid in interest over a 30 year note.
• Consumer Debt – Credit cards and auto loans are the two most popular forms of consumer debt and two of the most likely to have a high interest rate. The higher the interest rate, the more each percentage matters. In other words, there is a bigger difference between 14% and 15% than there is between 2% and 3%. So those crazy-high interest rates could mean that you’re actually paying more in interest than you are in principle.

The Line Between Investing and Paying Off Debt

I wrote an article about the “pay off your mortgage or invest the money?” debate and I actually proposed a compromise between the two, but the debate is real. Many people think it’s not worth your time to pay off your mortgage early since you can get a better return by investing the money. In other words, you can earn more by investing than you would save by paying off your mortgage early. Obviously this depends on both interest rates.

So where is the line between paying off debt and investing the money?

It’s definitely a blurry line. There’s no magic number, but when you can consistently earn more by investing than you save by paying off your debt, it’s at least worth considering. Just make sure you account for any taxes you may have to pay on capital gains if you’re investing in a taxable account.

And here’s a general rule: when it comes to high-interest consumer debt, pay it off before you start investing heavily for retirement. Feel free to have your emergency fund in place and contribute enough to your employer’s retirement fund to get the match (if they offer a match), but other than that, the debt comes first.

It simply doesn’t make sense to be earning 7% or 8%, while your paying 20% on your credit card’s revolving debt. The debt must go.

Remember the power of compound interest and make sure it’s working for you, not against you.

This guide will show you how to make it work for you.

There are few topics that have as much written about them and as much contrasting information as investing.

Just knowing that is enough to scare most people away from investing at all.

Is it really that difficult? Do you really need to devote years of your life to studying the most efficient way to invest?

It would seem that way, but in reality, not at all.

The problem with most investing advice is that someone is profiting (or attempting to profit) from it.

Investing is actually much easier to understand than you may think.

Stop Trying to Pick Hot Stocks

Turn on any business TV show and you’re going to see all kinds of people touting hot stock picks and attempting to explain the method to their madness. I can assure you, it’s mostly just madness, with some greed on top.

The vast majority of people in the world are terrible at picking stocks. You probably are too. I’m not that great at it.

So should we just give up on the stock market?

Absolutely not! It’s the most efficient way to invest for your retirement.

But picking individual stocks isn’t the answer. Unless you’re willing to devote hours (I’m talking at least 15 or 20 each week) to studying companies and picking winning stocks.

Simple is Better

So what’s the answer? You may have already guessed the answer, but I’m going to let you hear it from Warren Buffett first. When Buffett passes away, he wants his Berkshire Hathaway shares to be distributed to charity. This is what he wants done with the remaining cash:

“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”

Did you hear that? Index funds.

Most people who devote much of their time to picking stocks don’t beat the index. Why buy individual companies when you can buy the whole market? Or at least most of it.

It’s easy for a beginner investor to start picking stocks and see a few gains. Then they think they must be good at this. I know I did. Until I realized that my small gains were nowhere close to the massive gains of the market since we were in a very bull market at the time.

You must always compare your earnings to the index. The index is the standard.  And to consider yourself a good stock picker, you’ve got to beat the index consistently.

6 Simple Principles of Investing

There are some important things to know about investing, but once you know these rules and understand them, you are in the clear.

• Invest in index funds. I know I sound like a broken record, but the average investor should be investing in index funds. It takes a lot of time to research individual stocks and spending all that time doesn’t guarantee your success. Also, index funds provide automatic diversification within the stock market and they save your time!
• Spend your time elsewhere. You’re better off devoting your time to earning more money, improving yourself and doing the things you love. Even if you could beat the index by a few points, is it really worth the time you spend?
• Avoid paying high fees. One of the best things about index funds is the low fees. You shouldn’t be paying more than 0.5% on a good index fund. And honestly, you shouldn’t even be paying that much.
• Avoid taxes as much as possible. You’ll be avoiding high fees, but don’t let Uncle Sam take it either. Find the best ways to shelter your money, legally, from paying taxes. Your company’s 401k and/or an IRA is your best bet.
• Follow Buffet’s first rule. Buffett says the first rule is to not lose money. Why? Probably because a 50% decline fully offsets a 100% gain. Index funds are pretty well protected. Take more risks when you’re young, but don’t be stupid.
• Time, not timing, is everything. Don’t try to time the market. You can’t. I can’t. Can George Soros? It’s debatable, but we are not George Soros and buying low and selling high never happens consistently. Save yourself the stress and buy low-cost index funds. Think long term growth.

It’s Easy, Right?

Yes and no. The idea is easy, but the discipline and practice isn’t.  That’s why you set up an automatic investing plan.

Not to mention it seems a lot funner to try to pick winning stocks, doesn’t it? It’s not. Earning a higher return over the long haul will lead to much more fun down the road.  But you know that.

That’s it. In less than 1,000 words, you know the most efficient way to invest for retirement. This isn’t the begin all, end all advice to investing, but it almost is. I know several dividend investors that do well investing in large cap individual dividend stocks. I also know owning Berkshire Hathaway isn’t a bad idea and I actually recommend it below.

But all you really need to take away and remember is this:

Invest in low-cost index funds, avoid high fees and shelter from taxes.

You’re not going to hear that on TV.

Keep reading to see how to start investing, and for more ideas.

There’s no reason to figure everything out on your own.

Plenty of people have went before us, made mistakes, and figured out what they did wrong.

Let’s learn from them.

I have a friend who owns a farm in Missouri.

Actually, he owns a whole bunch of farms. Thousands of acres.

We will call him Gary. Because that’s his name.

Gary has taught me so much about money.

Some intentional, but some of most valuable lessons were things that he wasn’t actually trying to teach me.

Here is what I have learned from Gary and how we can all apply it…

The Life of Gary

Gary grew up in Northern Missouri.

He was used to the farm life and planned to own his own farm one day.

Now he owns more farms than he would have imagined.

He lives in a very nice home, right next to a nice pond for fishing.

It’s a peaceful life and he wouldn’t have it any other way.

So what happened between Gary’s childhood and now? Well that leads me to the first lesson Gary taught me…

1. Look for Opportunities and Seize Them

In the 1980s, the value of land dropped to record low prices.

It was devastating for many people who took out high-interest loans to buy million-dollar farms.

Gary saw the value of land plummeting and viewed it as an opportunity.

He started buying as much land as he could. He bought his first farm in his twenties.

He could have been scared off by the worthlessness of the land, but he chose to view it as an opportunity instead.

He was paying $200-$300 per acre for nice farmlands. You can add a zero to that for the price per acre today.

Always be looking for opportunities and always be prepared to seize them.

2. Explore All Your Options

There could be ways for you to make money right now that you don’t even know about.

Gary did some research and figured out about conservation programs for some of his unused land. Basically, the government pays him a certain amount of money per acre to not farm that part of his land. They only require that he mows it every few years.

If he didn’t know about that, he would have been making thousands of dollars less than he has been making for many years now.

He also learned that the government will stock your man-made ponds for free.

What? Free food, fishing and fun provided by the government? That never happens. Apparently, it does.

It was through research and learning that Gary was able to figure out about these options, and these are just a few of them.

Always explore all your options for whatever you’re interested in.

3. Do What Works for You

Gary is a farmer.

Farming works for him. He became a millionaire doing it.

Figure out what your opportunity is and what your options are.

You may not have a desire to run a farm, but you can still learn a valuable lesson here.

What opportunity will come in your lifetime? My guess is that you will have many. If you watch for them.

Gary invested in undervalued land. Now he is a millionaire.

Warren Buffett invested in undervalued companies. Now he is a billionaire.

Figure out what works for you and look for opportunities accordingly.

The Important Stuff

I have come to realize that if you keep the right mindset, success will follow you.

It’s important to always be learning. Constantly. We can learn from everyone if we want to.

Some people teach us what to do. Some people teach us what not to do.

Take something away from every experience. Use it to learn and grow as a human being.

Most importantly, never stop do that.

In 1982, when Forbes began ranking the richest people in the world, the qualification to be listed was only $75 million.

At that time, there were 13 billionaires on the list.

Today there are over 1,400 billionaires around the world.

From the stock market to businesses to commodities, they are all involved in some form of investing.

Here are some investing lessons we can learn from them…

1. Think Long Term

Buffett is famous for being a “value investor”.

He buys stock in undervalued companies and holds them for a long time…preferrably, forever.

Successful investing is not a get-rich-quick scheme.

Beware of hot stock tips, brand new company start-ups and shady investments that promise unusually high returns.

The bottom line: Go for long-term, stable investments over short-term, isky investments.

2. Make Mistakes (In a Good Way)

This type of thinking is common among successful people and successful investors.

Your mistakes are usually a determining factor of your success.

More success means more mistakes.

One of the richest men in the world also holds this mindset and that should tell you something…

The results are in. Successful people are good at failing.

The bottom line: Don’t be afraid to make mistakes. Use them to learn and grow.

3. Notice What People Do, Not What They Say

Who are you taking financial advice from?

Most people love to talk. They love to “give advice,” but is their money where their mouth is?

Do they practice what they preach? And how’s that working out for them?

Successful investing (success in general, really) is about taking action, not just talking about it.

The bottom line: Only listen to successful people; people who do what they say.

4. Do What Everybody Else Isn’t Doing

Wall Street is full of unsuccessful investors. Don’t get caught following the herd.

If everyone is doing it, you should (at minimum) be skeptical. (Think Enron)

The bottom line: Never make an investment, just because everyone else is doing it or just because someone told you to. Do your research and make wise investment choices.

5. Invest in Businesses, Not Earnings

Casinos are a great place to have a lot of fun and lose a lot of money.

You don’t need the stock market for that.

Don’t get caught up in day trading before you know what’s going on.

Your chances are better on the card tables.

You should be investing in the business, not chasing high earnings from one day to the next.

Furthermore, the price of a stock should be one of the least important factors in your decision when you are looking to buy into a company.

The bottom line: Research the company. Invest in the company. Don’t worry about market hype and what the people on TV are saying.

So, you’re interested in investing in the stock market. Perhaps, some individual stocks.

I won’t stop you. I think it’s a blast, and I have several.

But it is risky. Just know that. Of course, you can dramatically reduce the risk by being smart about it.

And that’s what you’re doing right now.

So let’s dive a little deeper into some terms and how stocks work.

When you go to buy your first stock, you may be a little confused about the terms involved. Especially the stock market order types. These are simple terms once you understand them and they may be highly beneficial to your stock portfolio.

The main terms you need to know initially are the terms for stock market order types. These are the basic ways you can order a stock.

Buy/Sell Market Order

Most of the terms are fairly self-explanatory and a market order is the most simple. A market order means you purchase X amount of shares for whatever the current market price is at.  That’s it!  So far, so good, right?

Buy/Sell Limit Order

A limit is a way to protect yourself.

You can set a sell limit order to sell your stock only at a certain price or higher. Or you can set a buy limit order to buy your stock only at a certain price or lower. Setting a limit is usually better than buying or selling at market value, because the market can change drastically and suddenly.

You can set a limit for the day only or you set it as “good until canceled,” which usually expires after 30 days if the price wasn’t met.  If your price wasn’t met, the purchase is cancelled.  No harm, no foul.

Buy/Sell Stop Order

A stop order is an order that you can set to buy or sell a stock once it reaches a certain price that you specify. A stop order turns into a market order once the stop price is reached. A buy stock order is set at a price above the current market value and a sell stop order is set at a price below the current market value. This is a way to protect yourself against losing too much on a stock.

Buy/Sell Stop-Limit Order

As it sounds, this is a combination of a stop order and a limit order. Once the price of a stock reaches a specified price, it turns into a limit order.

This way you can use a stop order, but control the price that you buy or sell at. Many traders use this type of order, as well as regular stop orders, for extremely high-risk stocks, such as penny stocks.

What You Need to Know

If you are planning on being a day-trader as opposed to an investor, then it may help you to do more research on stock order types, but for the investor who plans to hold their stocks for a very long time, you will not have as much use for these tools.

Trading and especially day-trading can be a very risky and dangerous business, but if you choose to take that path, please do your research on all types of stock orders.

Have you ever consistently watched the price of a stock?

You probably noticed that the price changed everyday.

It may have went up one day, down the next and back up the following day.

That’s typical for any stock.

But what causes a stock price to change so often?

It’s simple, all kinds of things…

What We Don’t Know

So, why does a stock price change?

The short answer is: nobody knows specifically.

“The Dow is down 50 points as investors react to news of [X].”

Stop it, you’re just making stuff up. “Stocks are down and no one knows why” is the only honest headline in this category.

*Taken from Morgan Housel’s article “Stupid Things Financial People Say“

There are many reasons for a stock price to change, but there is no one person that can tell you exactly why a specific stock’s price changed on any given day.

Enough about what we don’t know, let’s talk about what we do know…

The Economist Answer

The most foundational aspect of the stock market (like any market) is supply and demand.

See, like any market, even the mommy market.

It’s like anything else, if there are more buyers than sellers, the prices rise. If there are more sellers than buyers, the prices fall.

That explains the basic economic reason that a stock price would change, but that doesn’t really help you much, does it?

The Stock Trader Answer

Stock traders are different from investors.

It’s not necessarily bad to be a stock trader, but it’s not really my idea of sound financial practice and 9 times out of 10 it’s about as safe as Vegas.

They start young. Wait…what’s with all these babies?

So, what do traders notice about stock prices?

Stock traders attempt to track every single change.

That’s a lot, considering that stock prices change all the time due to:

• Company news…good or bad.
• Earnings reports…good or bad.
• Popular stock advisers endorsing or denouncing a stock.
• Analysts opinions.

The Investor Answer

Investors don’t really care about stock price changes.

Investors are not affected by trivial news and an “earning miss” here or there.

Warren Buffett definitely fits the investor profile, but where did all the babies go?

The market fluctuates. All the time. It’s too stressful to worry about every movement.

Investors don’t base their decisions on a stock price.

What You Need to Know About Stock Prices

There is one very important thing to understanding about buying stocks…

Stock prices don’t matter.

We will never fully know the exact reason for a stock price change in any situation.

A stock price alone doesn’t show you the value of a company.

We don’t invest in a company’s stock price, we invest in the company.

Whether you invest in individual stocks, index funds or mutual funds…you shouldn’t let stock prices alone affect your decisions.

You can watch the market every single day if you want to, but don’t let the daily changes lead you to make changes in your portfolio.

Hopefully this article gave you an insight into some things that can affect a stock price…basically everything can.

More importantly, hopefully you understand why stock prices don’t matter.

The Little Book That Beats the Market is a classic book on investing in the stock market.

Author Joel Greenblatt gives an innovative method for choosing stocks.

It’s pretty impressive, honestly.

Here are his main ideas, and the “magical formula” he uses.

He actually refers to it as “the magic formula,” and it just may be.

Main Idea #1: Invest in Index Funds, If You Don’t Want to Put in the Work

I said this in chapter 1. Warren Buffett has said this before. So it’s nothing new.

I’m not saying that Buffett and I are on the same playing field, I’m saying that I’ve said it before and an authority in the world of investing has said it before — two different perspectives indeed.

Let’s be honest, you really have two reasonable options when it comes to investing in the stock market:

1. Spend a lot of time finding individual stocks.
2. Invest in index funds if you don’t have the time for option one.

That pretty much sums it up. I mean, there are other options, but those are the two that make the most sense. Index funds have much lower fees than active mutual funds, and passive funds almost always beat active funds over the long haul, because around 80% of mutual fund managers don’t beat the market. The fact is, almost no mutual fund manager can beat the market, so why not invest in the market itself?

That’s exactly what an index fund does. An index fund is investing in the market.

Feel free to go read about it and see for yourself, but you’ll find it to be true. Index funds just make more sense than actively managed funds — over 80% of the time. So if you don’t want to put the time in to pick stocks (which takes a lot of time), invest in index funds.

You can open an IRA with TD Ameritrade in less than 15 minutes and start investing in index funds right now.

If you’re still interested in picking stocks and actually beating the market, see main idea #2…

Main Idea #2: Use This Magic Formula to Pick Individual Stocks

Greenblatt gives a formula for picking stocks that has continually outperformed the market, unlike mutual funds.

In fact, over a 17-year period, from 1988 to 2004, a portfolio using “The Magic Formula” returned an