What's the point of investing? Isn't it too risky and just gambling? Why should I even bother when I can just put money away into a savings account that I know will be safe? These are all common questions and valid concerns when it comes to investing. People hear "invest" and, depending on their age, generally think back to the great financial crisis, housing crash, and stock market plummet between the years of 2007-2009, or may even point to the recent crash/correction from March of 2020, or more recent to what we've seen in the first half of 2022 with rampant inflation.
No sugar coating or beating around the bush here. Investing carries risk. However, the amount of risk depends heavily on the investment strategy and somewhat on overall economic conditions. The stock market goes up, and the stock market also goes down. The closer the time period invested in the market, typically the more volatility there is. Fortunately, investing with long term goals over multiple years or even decades has some incredible results (more on that later in the post).
When in Doubt, Zoom Out
Let's look at some charts and see how the S&P 500 Index (the top 500 stocks in the United States) has performed over time. The S&P 500's performance is also considered as a benchmark for investors and many attempt to "outperform" the index's return each year.
If you invested into an S&P 500 fund on January 1, 2022 and sold on September 2, 2022 then you would have lost over 18% of your money. That's rough, buddy.
If you invested into the same fund on September 2, 2017 and did absolutely nothing over 5 years, you would have a total return of 59.43%, or just under a 12% annualized return each year. If you think that's impressive then check this out:
The past 40 years of investing into the S&P 500 has generated over a 3,000% cumulative return. Historically, and assuming earned dividends are reinvested and adjusting for inflation, the S&P 500 index has yielded an average annualized return of approximately 8%.
As implied by the data charts above, investing should be treated as marathon with long term goals. I personally view any investing over the short term with constant buying and selling as speculative trading. That's perfectly fine if it's a small portion of someone's overall net worth. Money you invest, especially in tax-advantaged accounts, should be left alone with no intention of touching it until retirement, absent of any financial emergencies where you may need to access some of the funds. Any short term uses of money (emergency fund, vacation spending, down payment on house, etc.) should remain liquid in a checking or savings account.
Compound Interest: The Key to Building Wealth
The stock market charts above are an example of perhaps the greatest element that exists when you invest over time: compound interest.
Compound interest is essentially the interest calculated on the initial principal. The number of compounds that occur can significantly impact the principal over a period of time. There's a bunch of fancy mathematical terminology and calculations that are involved but we're not concerned with that. Instead, let's see how it ties into investing. In simple terms, your money makes you money, which makes you more money, which then makes you even more money, and so on. It's basically an infinite money glitch if you utilize it right. Check out the breakdown below:
For simplicity, we'll start with $1,000 and assume a 10% return (interest) on your money at the end of each year for 10 years (this is also assuming you never add any money to the principal over those 10 years).
Year 0: $1,000.00
Year 1: $1,100.00
Year 2: $1,210.00
Year 3: $1,331.00
Year 4: $1,464.10
Year 5: $1,610.51
Year 6: $1,771.56
Year 7: $1,948.72
Year 8: $2,143.59
Year 9: $2,357.95
Year 10: $2,593.74
By the end of the decade, your $1,000 has grown to $2,593.74. However, if you add $100 to the principal each month over the course of 10 years, your $1,000 would end up growing to $21,718.65. Time is your best friend. The longer your investments are able to relax in their accounts and continue to compound, the more wealth you'll have in the future.
Let's look at the table below. It outlines hypothetical returns from consistently investing $100, $250, or $500 each month over time assuming the average stock market annual return of 8%. And this also assumes you'll never increase the monthly contributions over time.
| 5 Years | 10 Years | 20 Years | 30 Years | 40 Years |
$100 | $7,040 | $17,384 | $54,914 | $135,940 | $310,868 |
$250 | $17,600 | $43,460 | $137,286 | $339,850 | $777,170 |
$500 | $35,200 | $86,919 | $274,572 | $679,699 | $1,554,339 |
It really doesn't take a ridiculous amount of money to build wealth. The key is to choose a reasonable amount and contribute consistently over time. Now, let's contrast the example above with someone who transferred the same amount into their savings account over the same period. The average APY (annual percentage yield) for a savings account is 0.10% at the time of writing this article.
| 5 Years | 10 Years | 20 Years | 30 Years | 40 Years |
$100 | $6,012 | $12,054 | $24,229 | $36,527 | $48,948 |
$250 | $15,030 | $30,135 | $60,573 | $91,317 | $122,370 |
$500 | $30,060 | $60,271 | $121,147 | $182,635 | $244,740 |
That's a pretty sad comparison. As we can see, investors outperform savers over the long term. Every. Single. Time. But there is absolutely nothing wrong with saving money. I'm all for having a large cash position for emergencies and other large purchases, just don't keep the entirety of your net worth in cash. Start with any amount. Choose either a fixed dollar amount or percentage of your income to contribute to investments and keep it consistent. Your future self with thank you many times over. Utilize tax-advantaged accounts first and always participate in employer-sponsored programs for those retirement accounts, such as a 401(k) match, when possible.
As always, good luck on your financial endeavors.
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I am not a financial advisor and this is not financial advice. This is simply for entertainment purposes only where I share my personal insights and experience regarding personal finance and investing. Keep in mind that investing in any asset class carries the possibility of risk and make sure to do your own due diligence before you place any trades.
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