Let’s face it, for many investing is a difficult topic. The financial services industry has done an excellent job creating lingo and products that seem overly complex. Part of it is to justify their services; ‘If this investing stuff is too complex, give me your money and I’ll handle it for you!’ Technology is changing that dynamic and people are starting to realize that investing, particularly retirement investing, doesn’t require a Ph.D. in Math or Finance. The first step is to understand why investing is important and then to develop an openness to learning over time. This is not a forum for specific investing advice, but rather to discuss why investing is essential to reach our long-term financial goals.
Before we get into the reasons to invest, let’s make sure we are all on the same page what we mean by investing.
- Prior to investing funds in the stock market, make sure you have at least a base level emergency fund in place (in a separate savings account). Many people make the mistake of saving for retirement without building the foundation to prepare for the present. If you have enough money to build both at the same time, by all means, do so, but top priority should be to build an emergency savings foundation to avoid using credit cards or tapping into long-term investments.
- For our purposes, when we discuss investing, we are talking about long-term investing. We would not invest funds in the market needed for short-term or medium-term goals (i.e. less than five years). We’re discussing investing for goals such as building a nest egg for financial freedom or retirement.
- We are also not referring to the purchase of individual stocks or day trading. While that may be of interest to some, it is not advisable for the vast majority of the public. Investing has different levels and complexities. The majority of adults can develop the skills to drive an automobile safely on the roads, but we can all agree that most people shouldn’t try to become NASCAR drivers.
Now that we’re all on the same page, let’s talk about why you need to be investing!
1. You Can’t Build Wealth by Spending
Money is a resource, and like fire, it can both build and destroy. In order to be financially successful, we have to learn how to use our financial resources to build. There are really only three things you can do with money and how much of each you do can make all the difference in the world.
Spend – We do it every single day. We use our money to acquire products or services that we believe are of equal or greater value. The problem with spending is that most things decrease in value over time, so after we part with our hard-earned money, we’re left with a product or service that is immediately less valuable. If you use too many of your financial resources to purchase items that decrease in value, you cannot build wealth. This is why keeping up with the Joneses is so poisonous; it’s a race to the bottom.
Give – Interestingly enough, studies have shown that giving actually brings more and longer-lasting happiness than spending. You likely still remember the feeling of joy when you gave someone a great gift they really appreciated or truly helping someone in need. Giving also forces discipline with our finances, when you give money away, you become keener on how you manage the remaining funds. Giving is a very important aspect of personal finance and is a driving force for many to build wealth.
Save – There are different types of saving, but the idea is that you are using your financial resources with an expectation or goal of increasing its value in the future. That can take the form of a savings account, investing in the stock market, buying real estate, or even lending. This is the primary way to build assets and thus build wealth.
2. We’re On Our Own
If you are under the age of 50, it’s likely you do not have a pension and the future of Social Security is very uncertain, it may not even exist by the time we would be eligible for it. We also know that advances in health and technology that we are likely to live longer lives. We will need funds to provide for ourselves for a longer period of time without the financial assistance from business or government. If that’s not scary enough, let’s say you want to retire at 65. You work from age 25-65 (40 years), during that time you need to save enough money to live without new income for potentially 25 years (ages 65-90). People are having enough trouble building 6 months of expenses for an emergency fund. How about building for 25 years (300 months) of expenses or more? Putting a few dollars in a savings account here and there isn’t going to get the job done. You need a plan and you need to start as early as possible.
3. Inflation Can Drown Your Savings
When planning for the long-term future, people often forget to account for inflation. This can be a big mistake and can have serious consequences. Inflation is the increase of prices or the decrease in purchasing power over time. For example, 20 years ago one could go to a gas station and purchase gas for less than $1/gallon. As of this writing, it’s about $2.30/gallon, so a $20 bill that was more than sufficient in 1996 would not fill the gas tank today. Inflation (typically 2-3% per year) is like an ocean tide that is continuously raising the financial sea level. If the sea level is ankle-deep today and you stand still (don’t invest or grow the value of your assets), the tide of inflation will continue to rise and eventually you will be completely submerged. Like quicksand, standing still financially is actually sinking because inflation decreases the value of yesterday’s dollar. The only way to counteract inflation is to make sure your long-term savings are earning more than inflation.
4. Compound Interest Can Save You
So far we have given you some pretty dire news, spending won’t help, you’re all alone and the winter of inflation is coming for your assets! The good news is that you have a force of nature available that can fight the good fight and help you win and reach your financial goals, her name is compound interest. However, there are two sides of compound interest coin and you have to be on the right side to win.
If you have ever paid the minimum payment on a credit card, paid student loans, car loans or a mortgage, you have experienced being on the wrong side of compound interest. When you borrow, the investment the lender made earns interest that compounds and you pay them more in the future. This is why debt can kill wealth; your financial past is stealing from your financial future.
The right side of compound interest is much more appealing. When you invest, the earnings on your investments compound such that your future earnings also earn interest for you in the future.
Let’s use a simplified example. You save $500/month every month for 30 years. After 30 years you would have saved $180,000 cash. Now let’s say you invested the same $500/month every month for 30 years and it received 9% interest annually, it would total over $850,000.
The difference between the $180,000 and $850,000 is the power of compound interest. Compound interest is the sunlight that provides the energy to your investment seed to grow and harvest. The two major ingredients for compound interest to be effective are regular payments and time.
While saving is important, especially building the foundation of an emergency fund or short-term goals, investing is a necessity to build real wealth. Imagine a 15-year-old family member after watching a NASCAR race said to you they don’t want to learn how to drive. They explain that “It’s too technical, too dangerous and I’m not a car person!” You would probably explain to them how not learning to drive can negatively impact their quality of life. You would also likely explain to them there’s a huge difference between daily recreational driving and professional racing. The same applies to investing, excuses like, ‘I’m not good at math’, ‘it’s too complicated’, or ‘it’s too risky’ no longer hold. There is a huge difference between day-trading and retirement investing, technology has made investing accessible to many more people and because of headwinds like inflation and government uncertainty, in our opinion, it is riskier not to invest.