What is investing and why is it important in the long run?

Investing simply means making your money work by investing it, hoping it will become worth more. For example, instead of putting all your savings in a bank account at a low interest rate, you buy a share (piece of property) in a company or make a loan to a government or corporation (bond). You do this because you expect your investment to grow in the future - the stock may increase in value or pay dividends, and the bond pays interest. Investing is thus a way to build wealth for later, such as for buying a house, for retirement or to achieve financial goals.

It is especially important in the long run because time is a powerful ally in investing. Because of interest-on-interest (compound interest), money you invest grows exponentially as the years go by. A small amount you invest now can grow into a substantial amount decades from now, precisely because any gains are reinvested each time and generate new gains. In addition, inflation plays a big role: prices of products rise over time, reducing the purchasing power of stagnant savings.

In the Netherlands, savings rates have often been lower than inflation in recent years, meaning that the money in a savings account can lose value in real terms. Investing can help counteract this because, historically, it yields higher returns, on average, than saving. For example, over the long term, the broad stock market (for example, the S&P 500 index in the U.S.) achieved an average return of around 6-7% per year, significantly higher than the interest rate on a savings account. Although investments can fluctuate (or even decline) in the short term, the longer you give the investment time, the more likely you are to see a positive return.

How does investing work and what are the benefits?

In investing, you buy assets - that is, things with value, such as stocks, bonds, real estate or funds - with the goal of deriving financial benefit from them. In other words, you invest your money in something that you expect to become more valuable or generate income in the future. How does this work in practice? Suppose you buy shares in a company. With that money, the company can grow or make a profit, and as a co-owner, you also benefit: the share price may rise, so you can sell at a profit later, and some companies periodically pay out profits in the form of dividends. Or take a bond: you lend money to the Dutch state or a company, for example, and receive a fixed interest rate (coupon). So in both cases, your money potentially yields more money.

In particular, the advantages of investing lie in achieving higher returns than with long-term savings. Historically, healthy companies increase in value as the economy grows, and therefore stock markets grow with it. You "put your money to work" - while you study, work or sleep, the market can grow your investment. A well-known advantage is beating inflation: because you are making returns, your assets keep their purchasing power or even grow, despite everything becoming slightly more expensive each year. In addition, you benefit from diversification and economic growth: for example, if you have a basket of dozens of different stocks (e.g., through a fund or ETF), most economic blows in one place will often be offset by growth elsewhere. Investing also allows you to share in corporate profits globally - something you otherwise wouldn't have access to as an individual saver. Finally, starting to invest early, even with small amounts, can reap great benefits thanks to the long investment horizon. Someone who invests a monthly amount at a young age can accumulate significant wealth over the years purely through the effect of reinvesting and time.

Of course, there are risks in investing - prices can go up and down. Your invested money can become worth more, but also less. You see this especially in the short term: the stock market has good days and bad days (and occasionally longer times). An important advantage of a long-term approach, however, is that temporary declines often recover over time, especially if you invest widely. By staying calm and not selling in panic at every dip, you increase your chances of a good end result. In summary, investing works like this: you invest money in various sources, let time do its work, and in the long run reap the benefits of economic growth and compound returns.

What are stocks and bonds, and how do they work?

Stocks and bonds are the two best-known forms of investment. For beginners, it is important to understand exactly what these mean because they are the building blocks of many investment portfolios.

• Shares: A share is proof of partial ownership in a company. Think of it as if a company is a pie or pizza divided into pieces; each piece is a share. Once you buy a share, you become part-owner of the company for that piece. If the company does well - for example, because it makes a profit or grows - then you benefit too. The value of your share can rise, so that you can sell it later for more. In addition, the company may decide to distribute some of its profits to shareholders in the form of dividends (a kind of "bonus" in cash or extra shares). For example: if you own a share of Shell or ASML and the company achieves good results, you usually see the share price rise and you can be paid a dividend. But beware: if the company is doing less well, the share price may fall and you, as a shareholder, run that risk. On average, stocks offer the highest returns in the long term, but also have greater fluctuations in value in the short term.
• Bonds: You can think of a bond as the opposite of a stock: instead of being a co-owner, here you become a lender. It's basically a loan you give to a government or company. When you buy a bond, you lend a certain amount of money for an agreed period of time, in exchange for regular interest payments. At the end of the term, you (in theory) get your borrowed amount back. Because you usually get your deposit back and receive interest in the interim, a bond is considered a more defensive investment than a stock. The risk is lower: unless the party you lent to goes bankrupt (which is highly unlikely with the Dutch government, for example), you will get your money plus interest back. The downside is that the expected return is also lower than with stocks. Bonds are therefore often used to bring stability to a portfolio. As an example, the Dutch state regularly issues government bonds; if you buy such a bond, you will receive ~2% interest annually, for example, and at the end of the term you will get your original investment back.

How do these work together in practice? Many investors choose a mix of stocks and bonds in their investments. Stocks for long-term growth, and bonds for stability and a piece of fixed income. When stock prices fall, bonds often (not always) retain their value better, and vice versa. By diversifying across both categories, you can find a balance between risk and return that suits you.

Other investment options: gold, real estate, funds, ETFs and retirement investing

In addition to stocks and bonds, there are many other ways to invest. Diversification (spread) across multiple asset classes can further reduce risk. Here are some popular options:

• Gold and other precious metals: Gold has been considered a "safe haven" for wealth for centuries. People invest in gold (or silver, platinum) because it retains its value during times of economic uncertainty or high inflation. You can buy physical gold (e.g., gold bars or coins) or invest in a gold fund that tracks the price of gold. Gold gives no interest or dividends, but the price can rise if demand increases or people seek protection against inflation. In the Netherlands, you can buy gold through specialized traders or online brokers offering gold ETFs. The same goes for silver and other commodities: they are tangible assets that can be useful as insurance in your portfolio, but they do not produce income themselves.
• Real estate: Investing in real estate means investing in "bricks and mortar," or houses, apartments, offices or retail properties. Real estate can be attractive because it offers two sources of income: rental income (if you rent out the property) and potential appreciation in the value of the property itself. Many people think of real estate investment as buying a second home to rent out. That can be done, but requires a lot of capital and comes with practical concerns (maintenance, finding tenants, etc.). A more approachable way is through real estate funds or REITs (Real Estate Investment Trusts) - these are mutual funds that invest in a portfolio of real estate projects. You then actually buy shares in such a fund, and share in its rental income and value development. This way you can still invest in real estate with smaller amounts, without having to manage a property yourself. In the Netherlands, for example, there are listed real estate funds in which you can participate through your investment account.
• Mutual funds: A mutual fund is a collective pot of money from many investors managed by a fund manager. The fund invests that money according to a particular strategy. This can be anything: some funds invest globally in stocks, others just in bonds, or in specific sectors (technology, renewable energy, you name it). When you buy a unit (share) in a fund, you own a piece of the entire mix of investments the fund has. The big advantage is diversification: with one purchase, you indirectly invest in dozens or even hundreds of different securities. Moreover, the fund manager takes the work off your hands: he/she decides which shares or bonds are bought and sold. You do pay costs for this (the fund's management fee). An active mutual fund tries to beat the market by making smart choices; we'll come back to that in a moment under active vs. passive investing.
• ETFs (Exchange Traded Funds): An ETF is similar to a mutual fund, but has an important difference: ETFs usually passively track a particular index and are traded on the stock market like a stock. For example, consider an ETF that tracks the AEX index (the 25 largest listed companies in the Netherlands) or one that tracks the S&P 500 (500 large U.S. companies). Instead of a fund manager actively choosing, an ETF simply copies the composition of an index. This also gives you broad diversification, but often at a lower cost than active funds. ETFs are popular among beginning investors because they are simple, transparent and inexpensive. You can invest in an entire market in one fell swoop through an ETF. In the Netherlands, you can buy ETFs from virtually any broker or bank; for example, an MSCI World ETF that allows you to invest in thousands of stocks worldwide. ETFs thus offer a convenient way of passive investing (more on this in the next section).
• Pension investing (annuity): In the Netherlands, there is the possibility to make targeted investments for your retirement with tax benefits. This can be done through a retirement account or annuity account with a bank, asset manager (Vive for example) or a broker. The idea is that you deposit money in a special account intended for your retirement; on that deposited amount you get an income tax refund (within certain limits) or do not have to pay it. That money is then invested, often in a mix of stocks and bonds that suits your age and risk profile. Your wealth then grows through investments, gross (without paying tax on returns each year), and at retirement date you withdraw it in the form of an annuity payment on which you then pay tax. So the benefit is tax deferral/benefit as well as the investment return. Many Dutch people invest in this way for extra retirement in addition to their employer pension. By the way, realize that through your employer you probably already invest for your retirement: pension funds put your deposited premiums in large investment portfolios to grow them for later. In-house pension investment (via an annuity, for example) is supplementary and especially interesting if you have a pension shortfall, want extra money for later or, as a self-employed person, do not build up an employer pension. It is a relatively safe and smart way to make long-term investments because you won't need the money until retirement age anyway and you benefit from tax advantages.

Active versus passive investing

An important topic for beginning investors is the difference between active and passive investing. This is about whether you are trying to be smarter than the market, or rather moving with the market.

• Active investing: This involves trying to get better results than the average market through research, analysis and timing. An active investor (or fund manager) chooses specific stocks or other investments that he/she thinks will outperform others. Also, an active investor often tries to enter and exit the market at favorable times(market timing), for example, selling just before an expected decline or buying before an expected rise. So the idea is: pick the winners and avoid the losers, in order to achieve higher returns than "just holding everything." Active investing sounds appealing - who doesn't want to beat the market? - but in practice it turns out to be very difficult. You have to constantly monitor the economy and companies, make analyses and sometimes dare to intervene. Moreover, you make more trades, which incurs trading costs, and active funds charge higher management fees. Many studies have shown that only a small fraction of professional investors manage to consistently outperform the broad market after fees. In other words, most stock picks and expensive fund managers achieve lower long-term returns than simply the market average, precisely because of those costs and timing risks. Active investing can be fun and educational as a hobby (and some people beat the market for short periods), but it carries additional risks and uncertainty.
• Passive investing: This means that you don't try to beat the market, but follow it. For example, you buy an index fund or ETF that represents an entire index, and you hold it for a long time. Instead of looking for the new Apple or the next Amazon, you actually buy a piece of all the big companies at once. Passive investing is also called "index investing" or "diversification." The big advantage is that it is simpler and usually cheaper: you don't have to follow the news daily or do balance sheet analysis, and the cost of index funds/ETFs is low. By spreading widely, you also reduce the risk that one wrong choice will plummet your entire wealth - after all, you only have a small piece in each company. Although with passive investing you don't select the market's top winners, you don't completely avoid the big misses either; you get the average of everything. But remarkably, that average is often quite fine over the long term. Indeed, as actively managed investments lag due to costs and mistakes, passive funds have been shown to produce better returns on average than active funds over the long term. So with passive investing, you may not beat the market every year, but you do get market results - and historically the trend of markets has been upward. For most people (especially beginners), passive investing is a sensible strategy: it takes less time, it's quieter (you don't have to keep getting in and out) and the returns are often very competitive. A saying in the investment world is, "Time in the market beats timing the market " - in other words, just staying in the market (making time work) usually beats trying to time it. Passive investing embodies that principle.

In conclusion, start simple and be patient

Investing doesn't have to be higher math. This explanation has shown the basics: buy pieces of the economy, spread your risk, give it time and don't let daily fluctuations drive you crazy. Whether you are a student starting out with a small amount per month, or a working adult setting aside a portion of salary - the important thing is to start and learn by experience. If necessary, start with a small amount you can spare so that you become familiar with how it works. You will find that as you understand the terms and movements, investing can become quite interesting and even fun, especially when you see how your money can grow in front of you.

Always keep in mind that investing is a long-term process. There will be good years and not so good years, but by persevering, investing spread out (preferably many passive index investments for peace of mind) and not trying to time every move, you will steadily build a financial safety net. This is how you work step by step on your future wealth. Good luck with your first steps into the world of investing - hopefully you now have a little more grasp of the basic concepts, and remember: every great oak tree was once an acorn planted!