What is investing?

Kristia van HeerdenLatest, OUTstanding

There’s a difference between saving and investing. Saving is to protect money you’ve already made. That’s boring. Investing is a way to use your money to make even more money. That’s sexy. Your mission, should you choose to accept it, is to put your money to work. In this article, we are going to explain how.

A little business that grows up

You may think only some people can invest, because it requires a lot of mad skills that poor old you could never have. Not so! A listed company is just a small business that grew up. And then grew very fat. For that reason we are going to forget about listed companies and talk about how small businesses make money.

Let’s pretend your friend Khensani started selling cleaning detergents to her neighbours from home. At first, her clients were just the people in her street, but soon people from all over the neighbourhood started buying from her. She’s using the money she makes to buy even more detergents, so she can sell to more and more people.

The bottles are taking over her house. If she buys a garden shed to store them, she can keep even more bottles and sell to even more people. She’s earning enough money to be able to buy the shed, but then she won’t be able to buy more detergents. She needs cash.

You have some money saved up, so you become business partners. You offer her money now in exchange for a share of the profit she makes for as long as she has the business. Congratulations! You just bought a share.

How you make money

Khensani still owns and runs the business, you just gave her money for the shed. In addition to the bottles of product she owns and can sell, she now also owns a shed. Since you paid for a part of that shed, some of the money she makes if she decides to sell the shed is yours. If she sells the shed for more than she paid for it, you get your share plus a share of that profit. She also promises to share some of the profit she makes on each bottle of detergent with you.

Every month she transfers your share of the profits to you. Those are called dividends. You love them. Before long, the profits she shares with you is more than the money you gave her to buy the shed, but she just keeps on paying.

Eventually you decide to retire on a yacht. You are a detergent millionaire! Since you gave her money at the beginning, you are a shareholder of her business. You decide to sell your share back to her at the current value of the business, only the business has grown so much you get way more than you put in. You win again!

How is this investing?

Let’s say Khensani took her share of the profit, saved it up and rented the property next door. She bought a big shipping container to store her products, but she couldn’t get products fast enough to sell to everyone who wanted them.

She decides it would be cheaper to manufacture the products herself, so she needs a factory, machines and employees. You’ve already retired and all your money is going towards pimping your yacht, so you can’t help her.

She needs more business partners. She heard there’s a place where people just hang around with pockets full of money, looking for businesses that need investors. That’s a stock exchange. Since she needs more money than any one person typically has (because factories are expensive), she gets lots of investors to give her a little money. The stock exchange keeps track of all these small investors so Khensani can just focus on doing her work. To prove that they actually bought a part of her business, the stock exchange gives them a (digital) share certificate. Everyone who has a certificate gets a share of the profits, just like you did back when Khensani was working from home.

When other share certificate holders (you might like to call them shareholders) want to sell their part of Khensani’s business, they don’t need to sell the share certificate back to her. If they can find someone else who wants to have a bit of Khensani’s business, they just sell their certificate to that person at a price that person is willing to pay. That price is agreed upon between them, so Khensani isn’t involved at all. When Khensani makes it rain, the profit goes to the person who has the share certificate.

At this point you have crazy FOMO and you want back in on Khensani’s business. Khensani is too busy to talk to you and she’s still mad about the yacht, so you have to go find someone willing to sell their shares of her business. They don’t care that you knew Khensani. They want you to pay more for their shares than they did so they can make money. You believe Khensani will continue to rock it, so you agree to pay. Congratulations! You are a shareholder again!

OUTstanding Money blog

Being outstanding with your money doesn’t have to be hard. This series of articles will give you all the tools you need to get your house in order to start investing.

This series of articles was sponsored by OUTvest, and written by Just One Lap in 2018.  It’s timeless wisdom that needs to be out there – in public spaces where it can feed into ongoing discussions about long term financial wellness.