The statistics show that only a handful of people save money. Most people are living pay check to pay check and cannot even afford an emergency of $400 without getting into debt. This will cripple your finances and make it hard to repair them again. That is why it is important to create a savings routine (preferably an automated system) to make saving easier. Developing this habit will allow you get ahead of your get ahead of your finances, worry less and do more things. In essence, saving provides you with short-term relief. So what about long term? That is where investing comes in.
What is investing
Investopedia gives us the following definition “Investing is the act of allocating funds to an asset or committing capital to an endeavour (a business, project, real estate, etc.), with the expectation of generating an income or profit.” In simple terms, investing means cutting money into some kind of financial scheme, shares, property or company with the expecting of receiving profit in return. Making these investments is a good way to set aside money for the future so that you may live comfortably.
So why can’t you just use a savings account for long term investments? Although savings accounts are safe and insured, leaving your money in the bank over such long periods will result in a lower value due to inflation.
Why do you need to start making investments (now)?
Most people make the mistake of believing that they are too young, not knowledgable or simply don’t have enough money to invest. But that does not matter in investing. The sooner you start, with however little money you may have, the better because you will have time and compound interest on your side.
Firstly, investing is a way to assure your financial freedom. Because here’s the truth: At some point you’re going to have to stop working. The only question is whether you’ll be forced to stop before you’re financially prepared, or whether you’ll be able to choose to stop on your own terms. So your freedom is in your hands and it is best to start working on it now.
Starting now will let you make use of the power of compound interest. The Power of Compound Interest shows how you can really put your money to work and watch it grow. When you earn interest on savings, that interest then earns interest on itself and this amount is compounded monthly. Without you having to do anything, your money keeps earning more and more money all on its own. It’s also the real power of investing, and the longer you expose your money to the power of compound interest, the bigger the gains will be.
So we’ll demonstrate how the power of compound interest works using the following example.
Three people, Person A, Person B and Person C get the same annual investment return of 7% on their retirement funds, but they start investing at difference times. Let’s observe what happens.
Person A invests $5,000 per year beginning at age 18 and stops at age 28. They have invested for 10 years and $50,000 total.
Person B invests the same $5,000 but begins where Person A left off. He begins investing at age 28 and continues the annual $5,000 investment until he retires at age 58. Person B has invested for 30 years and $150,000 total.
Person C is our most diligent investor. He invests $5,000 per year beginning at age 18 and continues investing until retirement at age 58. He has invested for 40 years and a total of $200,000.
The value of their investments at retirement are as follows:
Person A: $ 602,070
Person B: $ 540,741
Person C: 1,142,811
Person B has invested 3 times as much as Person A, yet Person A’s account has a higher value. She saved for just 10 years while Person B saved for 30 years. This is compound interest: the investment that Person A earned in her 10 early years of investing is snowballing. The effect is so drastic that Person B can’t catch up, even if he saves for an additional 20 years.
The best scenario here is Person C who starts investing early and never stops. Note how the amount he has saved is massively higher than both Person A and Person B. It is most remarkable how simple his path to riches was. Slow and steady annual investments, and most importantly beginning at an early age.
How To Start Investing
There are two main options to start investing:
Invest through a broker:
Getting started is as simple as putting $500 into one of these recommended brokerage accounts and using it to buy a low-cost mutual fund or exchange-traded fund.
Invest through a Robo advisor:
And if that sounds like too much work, there’s an even easier way: robo-advisors. These are companies that will automatically invest your money in a way that tracks the overall stock and bond markets. They’re inexpensive and require very little money to get started.
Take Home Points: Why should you start investing today?
Compound interest favours those that start early, which is why it pays to start now. It’s never too late to start — or too early. If you are early in your career, it can feel like there are a lot of things competing for your money between student loans, saving for a house, retirement and more. However, saving now can give you a huge edge on your finances so you can retire stress-free. Also, if you are saving for your child’s education, the power of compound interest surely applies. Start saving when they are in diapers and not as they are starting their college search.
Which other ways do you invest? Please let us know in the comments section below.