How To Invest

Why Invest?

Why Should We Invest?
Before start throwing money into the stock market, mutual funds, or any other investment vehicles, the first question that we should ask ourselves is why do we want to invest?

The answer is pretty simple — to create wealth. If doing it correctly, investing can pay off in spades, without a lot of hassle. You can retire without having to worry about your kid’s education, and do the fun things you always wanted with proper stock market investing. All the riches utilize the power of investing to get their money to make them even more money. They get their money to start working for them so they can eventually stop working for money.

How Investment Can Help You To Achieve Your Goal
Whether you are now saving for your kids’ college, retirement, or some fancy new electronics you love, investment is going to help you achieve your goal faster.

Think about this: if you are putting $2,000 into the stock market now, with a 10% annual return (the S&P 500’s historical average), your two grand will grow into $34,989.80 after 30 years! It’s not the fortune you anticipated, but you’re well on your way with this amount.

If you don’t have that kind of money readily available to you, you can save up that amount over a gradual period of time before investing. If you do this when you’re young, you’ll have more time to build up more money for your investment over your lifetime. If you want to get a million dollars, all you have to do is invest a thousand dollars each year, get 10% on return (the average annual stock market return since 1926), and wait for 46 years to get your investment to pay off.

The power of compounding
When you first started out your investment with $1000, you may be thinking that a 10% annual return from the stock market is small. However, when allowed to compound over a period of time, it will turn small amounts into huge returns! The table below shows you how a single investment of $1000 will grow at various rates of return. Five percent is about what you might get from a certificate of deposit (CD) or with a government bond over time, 10% is about the historical average stock market return, and 15% is what you might get if you decide to learn how to pick your own stocks base on advanced investing techniques.

How is this possible? How do small amounts of money grow into huge sums? This is the result of the awesome power of compounding. I am sure you have heard of this term before but what does it really mean to you? Compound return is achieved when you invest a sum of money at a particular rate of return. Instead of taking out the interest earned after a year, you add it back to the principal sum and reinvest this larger sum. So the next year, the rate of return is on a larger principal sum. This continues until the returns a year become greater and greater!

Now imagine if you were to earn an average of $3,000 a month for your entire working life of forty years. If you were to just invest 10% of your income a month (i.e. $300) into the US stock market and allowed it to compound at 10%, how much would it grow to? Using a financial calculator, you will see that $300 a month invested at 10% will grow to $3 million! And that’s just from investing $300 a month. If you could invest $1,000 a month at 10%, it will grow to $10.02 million!

Start Investing As Early As Possible
Another way to approach this strategy is to think of the habits of two different children. Cecilia is very frugal with her money, and works frequently as a babysitter. Starting at the age of 15, she manages to put away $1,000 a year and gets a 12% return for ten years. Once that decade has passed, she decides to go out more often, and spends her return money on expensive trips and nice things for herself. However, her nest egg remains on the stock market.

Now let’s look at Alice, an early spender who blew her money on things she wanted right then. Once she becomes middle ages, her parents just have Social Security to retire on, and she realizes she should have saved. She starts putting away $10,000 a year for the next quarter of a century. As you can imagine, Cecilia ends up having more money than Alice at 65. By the time she hit that age, her strategy gave her almost two million dollars. In Alice’s case, she had to give up a lot in her last 25 years to save up $250,000 of her own money, getting a little under a million and a half. It’s true that they’ll both have good retirements, but the point is clear: Cecilia gained her fortune with money she barely even missed, earning most of it through interest. So when it comes to investment, the earlier you start the better.

Investing VS Saving
When you “save” in a bank savings account, a U.S. savings bond, a money market account, or Certificate of Deposit, you can expect to receive a rate of return that is tied to current short-term interest rates. You can even get a guarantee with some savings accounts that will promise you a set return rate as well as your money.

Investing is different from saving because it involves the risk that the value of your original investment could fluctuate, and no return is guaranteed. Yet, it’s hard to imagine that you can achieve your long-term goals without investing. History shows that investing in the stock and bond markets provides greater returns than most investors can earn through guaranteed savings. And, the risks of investing diminish over time, while the hidden risk of saving increases over time, because of taxes and inflation.

When you are aiming for a long-term financial goal, taxes and inflation can be your two worst enemies. Federal taxes subtract between 15% and 35% of the financial earnings generated by a savings account or any other taxable investment. The money you earn may also be subject to state taxes. Each year, inflation reduces the purchasing power of each dollar at an average annual rate of approximately 3.1%, according to Ibbotson Associates, an investment research firm.

When you think about these hurdles, it’s easier to see the need for a healthy return. If you’re really going to come out ahead of taxes and inflation, you need to think about investing in the stock and bond markets. Over the long term, and despite the ups and downs of both markets, they have outperformed “savings” by a wide margin.