Why should you think about investing?

On a daily basis, you most likely make small decisions regarding money, such as purchasing groceries, shopping online, and saving money for bills. However, it’s important to keep in mind that your financial life isn’t solely about these short-term expenses. It’s equally important to think about what’s on the horizon.

The decisions you make today can lay the groundwork for a life that’s comfortable and, if you’re fortunate, prosperous. Investing is an excellent means to help your money grow.

Simple Explanation

Investing is like gardening…

If you’ve ever tried growing tomatoes, you know that it demands both time and patience. Throughout the process, you’ll face numerous challenges such as annoying insects and the task of determining the right amount of water and fertilizer. However, as you gain knowledge and experience, the rewards of your hard work can be truly fulfilling. Even if you’re a novice, with perseverance and attention, you can achieve a successful harvest.

Money is Opportunity

Have you ever thought about how many of your future plans are dependent on having money? Do you want to buy a home? Send your kids to summer camp, or save for their college education? (Have you even thought about how expensive college might be in 20 years?) Maybe you dream of traveling, or starting a small business? Chances are, money will be required for any of these goals, or whatever else you have in mind. Investing can assist you in achieving them.

Investing can also have a significant impact on your retirement savings. It’s important to think about factors such as your expected working years, preferred location, hobbies, and even your future plans. Investing is a common way for individuals to accumulate wealth and plan for both short-term and long-term goals.

The Secret Behind Investing: Compounding Returns

Compounding, often referred to as the eighth wonder of the world, is truly an extraordinary phenomenon. But what exactly is this remarkable force?

Put on your gardening hat and think about this: you have a single orange tree that yields the sweetest fruit you’ve ever had. Having one tree is nice, but wouldn’t it be even better to have two trees, or even a whole orange grove?

As your tree bears fruit every year, you can collect some of those oranges to sow the seeds for additional trees. With each passing year, you can nurture more saplings, leading to the growth of your grove. This same idea can be applied to investing and reinvesting your earnings for compound growth.

If you want to grasp the concept of compounding returns, give this calculator from Investor.gov a shot. It’ll help you get a better understanding of how it works.

What It Means to Be an Investor

Investing isn’t simply about saving money and expecting it to grow on its own. When you purchase a stock or an ETF (exchange-traded fund), you’re essentially purchasing a share of a business (or multiple businesses). Your investment may also include bonds or other assets. Essentially, you become a part owner. As a shareholder, you go through the highs and lows of a company’s performance, which could result in a nice return if it does well, or a decrease in your investment if it doesn’t.

So, why isn’t everyone investing?

The answer to this question is pretty obvious – We’ve gone through some tough times, including a pandemic and a major market downturn. The reality is, many individuals just aren’t ready to dive into investing, and this is particularly true for young people. As of April 2022, approximately 58% of Americans have some stocks, but the percentage is significantly lower among young Americans. In fact, nearly 60% of American millennials have no investments in the stock market at all.

Why invest in the markets?

Fundamentally, investing is all about managing risk and seeking returns. While a savings account may yield a small interest rate, investing gives you the opportunity to aim for higher returns in the long term. For example, look at the S&P 500 index, which represents some of the largest companies in the US.

In the past 32 years, the S&P 500 index has shown an average annual return on investment around 9.79%, assuming reinvestment of all dividends. This means that between January 1990 and November 2020, a $100 investment in the S&P 500 would have grown to approximately $2,147.89, before accounting for expenses and taxes. (It’s important to keep in mind that past performance does not guarantee future results, and all investments come with risks.) The S&P 500’s yearly performance has seen some major ups and downs. For example, in 2017, the index experienced a remarkable 21.8% increase, but in 2018, it suffered a 4.3% decline. These fluctuations are just a small taste of what you could encounter.

While the US stock market has generally trended upwards, it hasn’t been a simple upward trajectory. Understanding this can better prepare you for market turbulence.

Investing vs. Saving

To get a clear picture of the difference between investment and savings, let’s consider a hypothetical situation that spans 40 years. Imagine you’re 25 years old right now and aiming to retire at 65. What would happen if you put $100 every month in a fund that tracks the general stock market?

Let’s say you begin with an initial deposit of $1,200 and the investment fund you choose grows by 6% each year for the next 40 years. (We won’t take into account dividends, taxes, or inflation.)

If you keep investing $1,200 every year and staying resilient through the market’s fluctuations, your money has the potential to reach close to $200,000. On the other hand, if you put the same amount in a savings account with an average annual interest rate of 2%, your total investment might only grow to around $75,000. (Adjusting your investment amount, rate of return, or the interest rate on your savings account can have an impact on the growth or reduction of the gap.)

Why the disparity? It all comes down to this: stocks are riskier. When you invest in a company, you’re essentially tying your financial fate to how well that company does – it could thrive, flop, or stay the same. On the other hand, savings are more secure (the bank uses your money for various purposes, such as mortgages and car loans), but the potential for growth is limited.

One more major difference to note is that the majority of banks provide insurance for deposits up to $250,000 through the Federal Deposit Insurance Corporation (FDIC). Moreover, it’s important to consider liquidity – in simpler terms, how easily can you access your money and sell your investments at a fair market value? Ultimately, the decision of finding the perfect balance between savings and investments rests with you.

How can my investment grow?

There are two ways your investments can grow: appreciation and dividends. Appreciation is when the value of an asset increases (similar to how your home may appreciate over time). Stocks can also appreciate, leading to an increase in their market value. Conversely, depreciation is a possibility as well.

Dividends are like your share of the profits when you own stocks. If the company makes money, it might decide to give you a portion of those earnings as dividends. However, you don’t have any control over whether the company will be profitable or if it will continue paying dividends. The company could potentially reduce or stop paying dividends without any prior indication.

A stock referred to as a “dividend stock” is typically considered a stable investment option, with the company consistently paying dividends to its investors. While it may not be the most exciting choice, it’s generally a reliable, potentially established company.

Your investment choices

We’ve covered different types of investments that can help you build wealth in various ways and provide different returns. Typically, savings accounts are the least risky, followed by bonds, and then stocks.

That’s why most investors don’t stick to just one type of investment. Instead, they prefer to create a mixed basket, also known as a diversified portfolio, to handle their risk and maximize their returns. Your portfolio could consist of index-tracking funds, individual stocks, bonds, and even real estate. Always remember, your portfolio should be tailored to suit your goals and what works best for you.

Having a diversified portfolio is similar to creating a huge garden filled with various fruits and vegetables. Even if the tomatoes fail to grow, you can still enjoy fresh strawberries, lettuce, and onions. It’s amazing to think that all you had in the beginning was just a packet of seeds!