Your best financial friend
Why Invest?
The Importance of Investing
Why are you investing? Are you hoping to save enough to retire someday? For your child's college education? For financial security? Or financial freedom?
Whatever your reason, it is important to invest in the stock market because there are few other reliable ways to grow your money in order to keep up with inflation. Inflation is the increase in the cost of goods and services. The stock market fluctuates, but the overall trend is growth averaging 10% annually. This growth allows you to keep up with the increasing costs of daily life.
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The stock market goes up more often than it goes down. The result is that you are statistically more likely to make money the longer you leave your money in the stock market, with a nearly guaranteed return if your timeline is greater than 20 years. Let me be clear, it is possible to lose money when you invest. The chance of you losing money is much higher if you have a short timeline. In fact, it is best not to invest money if you need the money in less than 5 years. Successful investing requires a long-term strategy. You will have to be patient.
Be Patient.
So forget day trading on an app when someone tells you that you should be investing. Day trading has more in common with gambling than growing your wealth. What we are talking about is called buy-and-hold investing. The best part about buy-and-hold investing is that you don't need to know that much about the stock market to invest successfully.
What Exactly Is Investing?
Investing is when you own assets that have the opportunity to increase in value or pay a dividend. When you own a stock, you own a small share of the company. When you own a bond you lend money to a company or government in exchange for interest.
As companies profit, they either invest money back into the company to increase the value of the company or pay dividends to shareholders, or both. If this all seems abstract, think of real estate investing. You can own a house that increases in value, but you can also make money from the house by receiving a dividend, such as rent.
The Power of Compounding
The most powerful part of investing is that if you start early, you don't have to save as much to make as much because the dividends you earn can be reinvested to buy more shares, which generally means you will earn even more dividends. Over time, you earn dividends on the reinvested dividends, and your portfolio value increases. This is called compounding growth. If you start investing early, you can invest less total money and still end up with more than someone who starts investing later in life. Let's look at three different investors who started investing at different times.​
Jessica
Started investing at age 25 Monthy Contribution: $300 Total Contributed (40 years): $144,000 Balance at Retirement: $718,686
Carlos
Started investing at age 35 Monthly Contribution: $600 Total Contributed (30 years): $216,000 Balance at Retirement: $680,118
Lilian
Started investing at age 45 Monthly Contribution: $1200 Total Contributed (20 years): $288,000 Balance at Retirement: $590,335
Notice that Jessica invests significantly less per month, as well as less total money, but still ends up with more than Carlos and Lilian. Even contributing twice as much as Jessica, Carlos still ends up with less than Jessica. Lilian contributes four times as much as Jessica and twice as much as Carlos and ends up with the smallest balance.
These calculations assumed a 7% return on investments. Because Lilian is closer to retirement, her portfolio might be more conservative and have a lower rate of return. Jessica, on the other hand, is more likely to invest more aggressively as she is far from retirement. So Lilian's balance may be lower and Jessica's balance may be higher. You can see why it is so important to start investing as early as possible!
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You might be saying to yourself, "That is great, but I don't have an extra $300 a month to invest, much less $600 or $1200!". Just invest as much as you can as early as possible and you'll be much better off than if you start investing later.
You can use the Investment Contribution Calculator to see how much your own contributions are likely to grow. You can see how adding $100 to your current contributions may impact your retirement balance. You can adjust the return to a more aggressive return (.09) or a more conservative return (.05) to see how the return can impact your current contributions.
Investment Contribution Calculator
When Shouldn't You Invest?
As I said earlier, you should not invest money that you will need in less than 5 years. The risk of loss is too high and there is little time for recovery in the event of a loss.
You also should not invest unless you have an emergency fund of at least 3-6 months of expenses, ideally in a high-yield savings account. Do not invest your emergency fund. You can invest additional savings after you have established your emergency fund, but the purpose of the emergency fund is to be there for you when your world is falling apart. Its job is not to grow your wealth. The one time you can invest without a fully funded emergency fund is if you are contributing to a retirement account with an employer match.
Finally, you should not invest if you have to borrow money to do so. How does one borrow money to invest? Well, you could take out a personal loan and invest the money. There are also types of trading that require borrowing money or shares from the investment firm called buying on margin and short-selling. These strategies are risky and can result in significant debt if the market behaves unpredictably.