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

Investing simply means letting your money work for you by investing it, hoping it will become worth more. Instead of putting all your savings in a bank account at a low interest rate, you buy, for example, a share (a piece of ownership) in a company or provide a loan to a government or company (bond). You do this because you expect your investment to grow in the future – the share can increase in value or pay a dividend, and the bond pays interest. Investing is therefore a way to build up capital for later, such as for the purchase of a house, for your pension or to achieve financial goals.

It is especially important in the long term, because time is a powerful ally when investing. Due to the interest-on-interest (compound interest), money you invest grows exponentially as the years pass. A small amount that you invest now can grow into a significant amount over decades, precisely because any profits are reinvested again and generate new profits. In addition, inflation plays a major role: product prices rise over time, which reduces the purchasing power of idle savings.

In the Netherlands, the savings interest rate has often been lower than inflation in recent years, which means that the money in a savings account can actually decrease in value. Investing can help counteract this, because historically it yields a higher return on average than saving. For example, the broad stock market (e.g. the S&P 500 index in the US) achieved an average return of around 6–7% per year over the long term, significantly more than the interest on a savings account. Although investments can fluctuate (or even fall) in the short term, the chance of a positive result increases the longer you give the investment time.

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How does investing work and what are the benefits?

When investing, you buy assets – which are things with value, such as shares, bonds, real estate or funds – with the aim of obtaining financial advantage from them. You therefore invest your money in something you expect will be worth more or generate income in the future. How does this work in practice? Imagine you buy shares in a company. That money allows the company to grow or make a profit, and as a co-owner, you benefit: the share price can rise, allowing you to sell at a profit later, and some companies periodically distribute profit to shareholders in the form of dividend. Or take a bond: you lend money to, for example, the Dutch State or a company, and in return, you receive a fixed interest (coupon). In both cases, your money potentially yields more money.

The advantages of investing lie mainly in achieving a higher return than with saving in the long term. Historically, healthy companies increase in value as the economy grows, and therefore, stock markets grow with them. You "put your money to work" – while you study, work or sleep, the market can make your investment grow. A well-known advantage is beating inflation: by generating returns, your capital maintains or even increases its purchasing power, despite everything getting slightly more expensive every year. Moreover, you benefit from diversification and economic growth: if you have a basket of dozens of different shares (e.g. via a fund or ETF), most economic blows in one place will often be compensated by growth elsewhere. Investing also makes it possible to share in corporate profits worldwide – something you, as an individual saver, would otherwise not have access to. Finally, starting to invest early, even with small amounts, can bring great benefits thanks to the long investment horizon. Someone who invests a monthly amount at a young age can build up significant capital over the years purely through the effect of reinvestment and time.

Of course, there are also risks associated with investing – prices can go up and down. Your invested money can become worth more, but also less. This is especially true in the short term: the stock market has good and bad days (and occasionally some longer periods). However, an important advantage of a long-term approach is that temporary drops often recover over time, especially if you invest broadly and diversified. By remaining calm and not selling in a panic at every dip, you increase the chance of a good final result. In summary, investing works as follows: you invest money in diverse sources, let time do its work, and reap the benefits of economic growth and compound returns in the long term.

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

Shares and bonds are the two best-known forms of investment. It is important for beginners to understand exactly what these entail, as they form the building blocks of many investment portfolios.

• Shares: A share is proof of partial ownership in a company. See it as if a company is a cake or pizza divided into slices; each slice is a share. As soon as you buy a share, you become a co-owner of the company for that slice. If the company does well – for example, by making a profit or growing – you benefit too. The value of your share can increase, allowing you to sell it later for more. In addition, the company may decide to distribute a portion of the profit to shareholders in the form of dividend (a kind of "bonus" in cash or extra shares). For example: if you own a Shell or ASML share and the company reports good results, you usually see the share price rise and you may receive a dividend payment. But beware: if the company is not doing so well, the price can fall, and you, as a shareholder, run that risk. Shares offer the highest average return in the long term but also have greater fluctuations in value in the short term.
• Bonds: A bond can be seen as the opposite of a share: instead of being a co-owner, you become a creditor here. It is essentially a loan that you give to a government or company. When you buy a bond, you lend a certain amount for an agreed period, in exchange for regular interest payments. At the end of the term, you get your loaned amount back (in theory). Because you generally get your principal back and receive interest in the interim, a bond is considered a more defensive investment than a share. The risk is lower: unless the party you have lent to goes bankrupt (which is highly unlikely with, for example, the Dutch government), you will receive your money plus interest back. The downside is that the expected return is also lower than with shares. Bonds are therefore often used to bring stability to a portfolio. For example: the Dutch State regularly issues government bonds; if you buy such a bond, you receive, for instance, ~2% interest annually, and at the end of the term, you get your original investment back.

How do these work together in practice? Many investors choose a mix of shares and bonds in their investments. Shares for long-term growth, and bonds for stability and a little fixed income. When share prices fall, bonds often (but 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.

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

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

• Gold and other precious metals: Gold has been seen as a "safe haven" for capital for centuries. People invest in gold (or silver, platinum) because it retains its value in 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 does not pay interest or dividend, but its price can rise if demand increases or if people seek protection against inflation. In the Netherlands, you can buy gold through specialist dealers or online brokers who offer gold ETFs. The same applies to 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," or houses, flats, offices or commercial premises. Real estate can be attractive because it offers two sources of income: rental income (if you rent out the property) and potential appreciation of the property itself. Many people think of buying a second home to rent out when it comes to real estate investment. This is possible, but it requires a lot of capital and comes with practical concerns (maintenance, finding tenants, etc.). A more accessible way is through real estate funds or REITs (Real Estate Investment Trusts) – these are investment funds that invest in a portfolio of real estate projects. You essentially buy shares in such a fund and share in the rental income and value development of that portfolio. This allows you to invest in real estate with smaller amounts without having to manage a property yourself. In the Netherlands, for example, you have listed real estate funds in which you can participate via your investment account.
• Investment funds: An investment fund is a collective pool of money from many investors managed by a fund manager. The fund invests that money according to a specific strategy. This can be anything: some funds invest worldwide in shares, others only in bonds, or in specific sectors (technology, sustainable energy, you name it). When you buy a participation (share) in a fund, you own a piece of the entire mix of investments the fund holds. 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 management fees of the fund). An active investment fund tries to beat the market by making smart choices; we will come back to that with active vs. passive investing.
• ETFs (Exchange Traded Funds): An ETF is similar to an investment fund but has an important difference: ETFs usually passively track a certain index and are traded on the stock exchange like a share. Think, for example, of 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 US 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 lower costs than active funds. ETFs are popular among novice investors because they are simple, transparent, and cheap. You can invest in an entire market in one go via an ETF. In the Netherlands, you can buy ETFs from almost any broker or bank; for example, an MSCI World ETF with which you are diversified across thousands of shares worldwide. ETFs therefore offer an easy way of passive investing (more on this in the next section).
• Pension investing (annuity): In the Netherlands, there is the possibility to invest specifically for your pension with tax advantages. This can be done via a pension account or annuity account at a bank, asset manager (Vive for example) or a broker. The idea is that you deposit money into a special account intended for your pension; you receive income tax back or do not have to pay it on that deposited amount (within certain limits). That money is then invested, often in a mix of shares and bonds that suits your age and risk profile. Your capital then grows through investments, gross (without paying tax on returns every year), and upon reaching pension age, you withdraw it in the form of an annuity payment on which you then pay tax. The advantage is therefore tax deferral/benefit as well as the investment return. Many Dutch people invest in this way for an extra pension in addition to their employer's pension. Moreover, realise that you are probably already investing for your pension through your employer: pension funds invest your deposited premiums in large investment portfolios to make them grow for later. Pension investing on your own (via an annuity, for example) is supplementary and is particularly interesting if you have a pension shortfall, want extra money for later, or do not accrue an employer's pension as a self-employed person. It is a relatively safe and smart way to invest long-term because you do not need the money until your retirement age, and you benefit from tax advantages.

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Active versus passive investing

An important topic for novice investors is the difference between active and passive investing. This is about the question of whether you try to be smarter than the market, or simply move with the market.

• Active investing: This involves trying to achieve better results than the average market through research, analysis, and timing. An active investor (or fund manager) selects specific shares or other investments that he/she believes will perform better than others. An active investor also often tries to enter and exit the market at favourable moments (market timing), for example, selling just before an expected drop or buying before an expected rise. The idea is to pick the winners and avoid the losers, to achieve a higher return than "just holding everything." Active investing sounds appealing – who doesn't want to beat the market? – but in practice, it proves very difficult. You have to constantly monitor the economy and companies, make analyses, and sometimes dare to intervene. Moreover, you make more transactions, which involves transaction costs, and active funds charge higher management fees. Many studies have shown that only a small proportion of professional investors succeed in consistently outperforming the broad market after costs. In other words: most stock-pickers and expensive fund managers achieve lower returns in the long term than simply the market average, precisely due to those costs and timing risks. Active investing can be fun and instructive as a hobby (and some people beat the market for short periods), but it entails extra risks and uncertainty.
• Passive investing: This means you do not 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 the long term. Instead of looking for the new Apple or the next Amazon, you actually buy a piece of all large companies at the same time. Passive investing is also called "index investing" or "diversifying." The great advantage is that it is simpler and generally cheaper: you do not have to follow the news daily or perform balance sheet analyses, and the costs of index funds/ETFs are low. By diversifying broadly, you also reduce the risk that one wrong choice will sink your entire capital – after all, you only have a small piece in each company. Although with passive investing you do not select the top winners of the market, you also do not fully avoid the big misses; you get the average of everything. But remarkably, that average is often perfectly fine in the long term. Even more so, because actively managed investments lag due to costs and mistakes, passive funds generally yield better returns than active funds over the long term. With passive investing, you might not beat the market every year, but you get the market results – and historically, the trend of markets is upward. For most people (especially beginners), passive investing is a sensible strategy: it takes less time, it is calmer (you do not have to enter and exit constantly), and the return is often very competitive. A saying in the investment world is: "Time in the market beats timing the market" – in other words, simply staying in the market (letting time work) usually beats trying to time it. Passive investing embodies that principle.

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Finally: start simply and be patient

Investing does not have to be rocket science. This explanation has shown the basic principles: buy pieces of the economy, spread your risk, give it time and do not be rattled by daily fluctuations. Whether you are a student starting with a small amount per month, or a working adult setting aside a part of your salary – the most important thing is to start and learn through experience. Start with a small amount that you can afford to lose, if necessary, so 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 for you.

Always keep in mind that investing is a long-term process. There will be good years and less good ones, but by persevering, investing diversified (preferably many passive index investments for peace of mind) and not trying to time every movement, you will steadily build a financial safety net. This is how you work towards your future capital step by step. Good luck with your first steps in the investment world – hopefully, you now have a better grasp of the basic concepts, and remember: every great oak was once an acorn that was planted!

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