Why should I think about investing?

Gist

• Investment has the capacity to enhance wealth-building compared to just saving.
• The earlier you start investing, the more time your money has to increase.
• The concept of compounding returns can accelerate the accumulation of your money.

Every day, you likely make many small financial choices such as purchasing groceries, shopping online, and saving for bills. However, it's crucial to remember that your financial life includes more than just immediate expenses. It's important to consider future possibilities as well. The choices you make now can have a significant impact on your financial future, and investing is an effective strategy for increasing your wealth.

Money is Opportunity

Do you rely on money for most of your future plans? Unless you're like Marie Kondo, it's safe to say that a majority of your goals require financial resources. Do you dream of owning a house or sending your children to summer camp or college? With college expenses projected to skyrocket in the next 20 years, it's hard to imagine how much it will cost. Perhaps you hope to travel or start a small business - no matter what, you'll need money to achieve these goals. Investing can help you reach your objectives. Investing is also crucial for planning your retirement. You should consider factors such as your expected retirement age, desired location, hobbies, and lifespan. Investing is a popular way for many individuals to build wealth and plan for both short and long-term aspirations.

The Secret Behind Investing: Compounding Returns

The phenomenon of compounding has been dubbed as a remarkable force, often referred to as the eighth wonder of the world. So, what exactly is this extraordinary power?

Let's imagine you are a gardener. You have a single orange tree that yields the most delicious fruit. While having one tree is fantastic, wouldn't it be even better to have two trees, or even an entire orange grove?

As your tree produces fruit every year, you can take some of the oranges and use them to grow new trees. Over time, you can cultivate more saplings, and your small grove can expand exponentially. This same principle can be applied to investing, where you can reinvest your returns to generate compound growth.

To gain a better understanding of compounding returns, you can use the calculator available on Investor.gov.

What It Means to Be an Investor

Investing involves more than simply saving money with the expectation that it will increase on its own. Instead, purchasing a stock or an ETF means purchasing a component of a business or businesses, which may also include bonds or other assets. By doing so, you effectively become a partial owner of the entity. This status as a shareholder means that you will experience the highs and lows of the company, which could result in financial gain if it prospers or a loss if it falters.

So, why isn’t everyone investing?

It is likely that you can anticipate the response to this inquiry. Our experiences have included challenging periods such as a pandemic and significant market decline. As a result, a large number of individuals are not yet prepared to engage in investing, especially young people who are lagging behind. Although approximately 55% of Americans possess some stocks, the percentage is lower for the younger generation. In fact, almost 60% of American millennials do not have any investments in the stock market.

Why invest in the markets?

Investing primarily involves weighing risk against potential reward. Although a savings account may provide a small interest rate, investing has the potential to yield a higher return in the long term. The S&P 500 index is a collection of stocks that represents some of the largest American companies. Over the past 30 years, the annualized return on investment for the S&P 500 was approximately 7.5%, meaning that a $1,000 investment made between January 1990 and August 2020 would have grown to around $9,300 before taxes and expenses. However, the S&P 500's annual performance has varied significantly, with a 37.5% rise in 1995 and a 37% fall in 2008. This is just one example of the fluctuations that can occur when investing. Although the US stock market has generally grown over time, it has not been a linear process. This knowledge may help you prepare for the volatility that can occur in the market.

Investing vs. Saving

To comprehend the contrast between investing and saving, let us examine a hypothetical scenario spanning 40 years. Suppose you are presently 25 years old and aim to retire at 65. How would things appear if you allocate $100 every month to a fund that tracks the general stock market? For our illustration, let us assume you began with an initial deposit of $1,200, and the fund grows by 6% annually over the next 40 years, without considering dividends, taxes, or inflation. By regularly investing $1,200 yearly, and enduring the market's fluctuations, your money could potentially reach approximately $200,000. Conversely, if you saved the same amount in an account with an average annual interest rate of 2%, your total investment might only amount to around $75,000. The disparity arises because stocks are riskier, and investing in a company ties your financial future to that company's performance. Savings, on the other hand, offer more stability, but with less growth potential. Furthermore, deposits in most banks are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC), and liquidity is another key consideration. It is up to you to decide the appropriate balance between investing and saving.

How can my investment grow?

There are two ways for your investments to increase: appreciation and dividends. Appreciation means that the value of something goes up, just like a home's value can appreciate. The same goes for stocks, which can increase in market value. On the other hand, depreciation is also a possibility.

Dividends are your share of the company's profits. If you own a stock and the company earns a profit, they may choose to distribute a portion of that profit to you as a shareholder. However, you have no control over whether the company actually makes a profit or pays a dividend. Additionally, the company may choose to reduce or stop paying dividends at any time without warning.

When investors refer to a stock as a "dividend stock," it usually means that they see the associated company as stable and dependable, paying reliable dividends to shareholders. These companies may not be the most talked-about or trendy, but they are typically established and potentially older businesses.

Your investment choices

Various investment options offer distinct ways to generate wealth and yield different outcomes. Typically, savings accounts have the lowest risk followed by bonds and then stocks. Hence, most investors prefer to create a diversified portfolio that encompasses a range of investments to manage their risk and enhance their returns. This might include index funds, individual stocks, bonds, and real estate, all tailored to meet their unique objectives. Just like a big garden with multiple fruits and vegetables, a diversified portfolio ensures that even if one investment underperforms, others will continue to thrive, bringing overall success. It's amazing to think that it all started with just a packet of seeds.