What is investing?
When you invest, you purchase something with the expectation of profiting off of it in the future.
In the 1990s, some people thought they were making smart “investments” in Beanie Babies and McDonald’s toys. But traditional investments include things like ownership in a business, real estate assets, or lending money to a person or company in exchange for interest payments.
Why Should I Invest?
Merely saving money isn’t enough to build wealth. A bank will keep your money safe. But, each year, inflation makes every dollar you’ve tucked away slightly less valuable. So, a dollar you put in the bank today is worth just a little less tomorrow.
Comparatively, when you invest, your dollars are working to earn you more dollars. And those new dollars work to earn you even more dollars. The snowballing force of growth is known as compound growth.
Over the long term, investing allows your assets to grow over and above the rate of inflation. Your past savings build on themselves, instead of declining in value as the years pass. This makes it significantly easier to save for long-term goals like retirement.
When Should I Start Investing?
Yesterday. But if you haven’t started yet, today is a great second choice.
In general, you want to start investing as soon as you have a solid financial base in place. This includes having no high-interest debt, an emergency fund in place, and a goal for your investments in mind. Doing so allows you to leave your money invested for the long-term – key for maximum growth – and be confident in your investment choices through the natural ups and downs of the market.
Benefits of starting young
Compound growth requires time. The earlier you start investing, the more wealth you can create with fewer dollars.
When it comes to investing, time is your most powerful tool. The longer your money is invested, the longer it has to work to create more money and take advantage of compound growth. It also makes it far less likely that one harsh market downturn will negatively impact your wealth as you’ll have time to leave the money invested and recover its value.
Let’s look at an example:
Since 1928, the average return of the S&P 500 (a set of 500 of the largest public companies in the U.S. that is often used to approximate the stock market) is about 10%.
So, let’s say you’re 25 and put $5,000 in the S&P 500. You see a 10% increase in value each year, letting your money continue to grow. When you turn 65, you open your account to find you have over $226,000. An excellent retirement gift to yourself!
However, if you waited until you were 35 to start investing, your value at 65 would only be $87,000. Still impressive, but fewer than half of what you would have had if you started a decade earlier.
Pay off high-interest debt first
View paying down high-interest debt as investing until you no longer have those debts. Every dollar toward principal earns you an instant return by eliminating future interest cost.
If you still have high-interest debt, such as credit cards or personal loans, you should hold off on investing. Your money works harder for you by eliminating that pesky interest expense than it does in the market. This is because paying off $1 of debt balance saves you 12%, 14%, or more in future interest expense. More than traditional investments can be expected to return.
Focus on getting out of debt as fast as you can, then dive into investing.
Have an emergency fund in place
To reduce the risk of having to pull money out of your investments early, have an emergency fund to protect from life’s unexpected twists and turns.
Remember how we said time is the most powerful tool? To start investing, you have to be set up to let that money stay invested. Otherwise, you limit your time horizon and could force yourself to withdraw your money at the wrong time.
To protect yourself from unexpected expenses or job layoffs, save a sufficient emergency fund for your needs. Do not plan for your investment accounts to be a regular source of cash.
Starting small is OK
Sometimes people think they can’t start investing until they have a significant amount of money. But this means many people give up years of compound growth waiting until they feel rich enough. No matter how small, get your money working for you as soon as possible.
Consider our previous example of the $5,000 invested at 25- or 35-years-old. Pretend for a moment the 35-year-old didn’t have $5,000 to invest at age 25, but she did have $500. And she thought, maybe, she could scrape together $50 a month to add to her $500 investment.
If she invested $500 at age 25, and then $50 a month until she had put away a total of $5,000, she would have almost $174,000 at retirement age. That is double what she would have had if she waited until she had $5,000 at age 35.
Starting small makes a significant difference, especially if it means you get in the market sooner.
Where to Focus First
When first starting to invest, it can be hard to choose between the multiple types of investment accounts. As you begin, remember to focus where you see the most value.
First, contribute enough to your employer-sponsored retirement plan to get the full value of any match the company offers. This is free money and an instant return on your investment. If you aren’t sure if your employer offers a contribution match, reach out to HR for the most up-to-date policies.
Second, max out contribution limits on your tax-advantaged accounts – if you are primarily saving for early retirement or a child’s college. The tax benefits in these accounts save you money that you don’t want to turn over to Uncle Sam unnecessarily.
Finally, invest any excess capital in brokerage accounts. This will help you save for long-term goals like buying that vacation house in ten years.
Note: The above assumes that you have paid off all high-interest debt and have a solid budget in place. If you haven’t done those things yet, get them squared away before you start investing.
