Investing from scratch: where to invest your money

In life as in your business, you only have three ways to grow your money:

1. Earn more.
2. Cut your expenses.
3. Put your money to work. In other words, invest.

And that’s it. There’s nothing else.

In my experience, the first route is the most powerful, but it comes at the cost of time.

Starting with the second is great if your money management is, let’s say, “messy”. It costs less than the previous one and you see the results almost from day one. But it has a lower limit you can’t cross without flirting with third-world territory.

The third, however, is the most comfortable. Especially if you have capital or a certain monthly investment capacity. Because thanks to it, you won’t have to spend much time or effort to get returns. 

That said, it’s not short term —that would be trading and I’m not going to talk about that here— but your time horizon is measured in years. Five at least. Ten, better. And staying invested your whole life is the scenario you should really be considering.

With that idea in mind, I want to explain what investing actually is, where and how you can do it.

To do that I’ve created a series of articles covering this topic, designed to be read in order, and this first instalment is the one you’re reading now.

The goal is not for you to become a mega expert —it would be naive of both you and me to expect that from seven articles— but for you to learn the minimum I believe anyone should know about investing.

Even if you’re starting from zero, you’ll see that it’s quite a bit simpler than you probably had in mind.

Here are all the linked articles; I’m pretty sure they’ll be very useful to you:

1. Investing from scratch: where to invest your money. (This is the one you’re reading).
2. Types of assets you can invest in according to their role in the portfolio.
3. How to buy assets: investment vehicles.
4. Investment platforms: where to buy investment vehicles or assets.
5. Risks and protections when investing.
6. My investment system.
7. Wealth: how to grow it, protect it and pass it on.

What investing is

Investing is nothing more than putting your money to work so it grows or generates income for you over time.  

The problem is not that it’s difficult, but that we’re rarely taught it well, given the level of knowledge about money management in Spain. Yes, most of us are financial illiterates for the most part.

And the people who aren’t, because it’s their job, usually explain themselves with too much jargon or by mixing concepts that an ordinary person can’t follow. 

However, it’s simpler than it seems. And once you organise it properly in your head, everything fits.

Why investing is necessary

Contrary to what you might think, it’s not to get rich (it’s not that easy, even if you invest), but for another main reason: inflation.

Inflation is the general rise in prices over time.

Put simply: with the same amount of money, you can buy fewer things than before.

For example, today a coffee costs €1.50 and in a few years it costs €2. That’s the effect of inflation. Your money hasn’t changed, but its value has, because it has lost purchasing power.

Inflation doesn’t mean one specific product goes up, but that many prices rise together: food, housing, transport, services, etc.

And careful, inflation is encouraged. Governments look favourably on moderate inflation of around 2%, because it makes their sovereign debt worth less.  

The problem is that, on top of that, real levels over many periods are not 2%, but more like 5 or 6%, with the corresponding erosion of your purchasing power.

That’s why investing is important: if your money doesn’t grow at least at the pace of inflation, in practice you’re losing purchasing power, even if the number in your account doesn’t change.

By the way, inflation is generated automatically when energy or housing becomes more expensive, but also actively when the amount of money in circulation is increased: you should know that central banks and states print money without any real backing behind it. This is a major problem in today’s economy and with fiat money.

Compound interest

Compound interest is, simply, making money on the money you’ve already earned.

Your investment generates a return. If you reinvest that return, it starts generating more returns by itself. Over time, that effect accumulates and growth accelerates.

A simple example:

• You invest €1,000
• You get 10% per year, so by year-end you’ve earned €100 and now have €1,100.
• So the following year you don’t generate returns based on €1,000, but on €1,100. This means you’ll earn €110 instead of the previous year’s €100, assuming the same 10% return is maintained.

Holding that reinvestment for several years is what creates a significant difference at the end of the period, greater the longer the period is.

That’s why compound interest is not linear, it is exponential. At first it looks like nothing is happening, but over the years growth shoots up.

What you need for it to work

For compound interest to do its job, you need three things:

• Time: it’s the most important thing.
• Reinvestment: don’t take the profits out.
• Consistency: stay invested (same as the previous point).

And that’s it.

To achieve the effect of compound interest extra contributions are not necessary, though they never hurt, of course.

Which instruments make it easier to achieve

Although I’ll talk about asset types and investment vehicles in later articles, I’ll give you a preview here.

Because I want you to know that not every product lets you make good use of compound interest. Some make it much easier than others.

#1. Investment funds (especially accumulation funds)

They’re probably the simplest way.

Profits (including dividends) are automatically reinvested inside the fund itself. You don’t have to do anything and, on top of that, you don’t pay tax until you sell.

This allows capital to grow without interruptions.

#2. Accumulating ETFs

They work similarly to funds, but are traded on the stock exchange.

They also reinvest profits automatically, which favours compound interest. 

The main difference is tax treatment: in Spain you can’t switch ETFs without paying tax on gains, unlike what happens with investment funds.

#3. Dividend stocks (if you reinvest them)

Here compound interest depends on you.

If you receive dividends and reinvest them, you can achieve a similar effect. If you don’t, growth slows down.

Also, every time you receive dividends you pay taxes, which slightly reduces the compounding effect.

#4. Pension plans

They also allow compound interest, because the money stays invested for long periods and is not taxed until redemption.

The problem is the lack of liquidity, which limits their flexibility.

#5. Interest-bearing accounts and deposits

Here too compound interest exists, but it is very limited.

Interest rates are usually low and, on top of that, taxed every year, which reduces the cumulative effect.

A summary of compound interest

Einstein is credited with saying that compound interest is the “eighth wonder of the world”, although there is no evidence that he actually said it.

It is very powerful and depends less on the asset you choose than on what you do with its returns and, above all, on time for which you decide to keep those returns invested.

If you’re looking for the easiest way to take advantage of it, products that automatically reinvest and defer taxation are the ones that enhance it most.

That’s why, for most people, funds (especially index and accumulation funds) are one of the most effective ways to benefit from compound interest without making things complicated.

Conclusions

Investing is not a path to getting rich quickly, but a tool to avoid losing purchasing power over time. If your money doesn’t grow at least at the rate of inflation, in real terms you become poorer, even if the number in your account doesn’t change.

The compound interest is the real engine of long-term investing, but it requires time, consistency and reinvestment. At first progress is slow and barely visible, but over the years growth accelerates significantly.

Not all products let you take advantage of this effect in the same way. Products that reinvest automatically and make accumulation easier —such as investment funds— simplify the process and reduce errors compared with other options where you depend more on your own decisions.

Finally, the key is not to find the perfect investment —there isn’t one— but to maintain a coherent system for years. Understanding the basics, staying consistent and avoiding changes to the process, however tempting they may be, is what really makes the difference over the long term.

Next steps

If you want to go a little further, I invite you to continue with the next article in the series:

1. Investing from scratch: where to invest your money. (This is the one you’re reading).
2. Types of assets you can invest in according to their role in the portfolio.
3. How to buy assets: investment vehicles.
4. Investment platforms: where to buy investment vehicles or assets.
5. Risks and protections when investing.
6. My investment system.
7. Wealth: how to grow it, protect it and pass it on.