We all need money to live and it can be made via salary by investing your time and skills, or through returns on monetary investments. For many people, it’s a combination of the two.
Before you can really start investing your hard earned money you first need some amount of money saved.
Check out this article for ideas on how to save extra money each month: 7 Ways To Save Money Each Month
A common misconception is that you need thousands of dollars saved to start investing, but that’s not the case. While you may need thousands of dollars to invest in real estate, businesses, and expensive stocks, there are other low cost options you can start investing in with less than $500.
Save then invest.
Before I get into why you should invest your money and not just save your money, let me first say there is nothing wrong with saving your money. After all, if you haven’t saved any money then what are you going to invest?
Related: Make Your Money Work For You
Don’t invest all of your money.
While I do suggest investing a portion of your savings, it’s not wise to invest all of your savings. There is always some degree of risk associated with investing. You don’t want to end up in a situation where you invest all of your money to find that you made a bad investment and all of your money is now gone. This brings me to my next point.
Have an emergency fund.
You should always have an emergency fund in your savings account to help cover the cost of living if you were to lose your job, have an unexpected medical expense, or have to repair your car. I recommend having 3 months of living expenses available at all times.
The disadvantage of saving money without investing.
Investing your money can generate more wealth in time than strictly saving it. It also helps you to keep up with inflation.
For example, as your hard earned money sits in your bank account or sock drawer (for those of you who don’t trust the banks), it is slowly “losing value” due to inflation. The average annual inflation rate is around 3.2%, while the average interest rate in a savings account in 2017 is about 0.06%. This means the average rate of inflation is approximately 53x greater than the average interest rate for a savings account (maybe using your sock drawer isn’t such a bad idea).
Comparing the average annual inflation rate to the average interest rate of a savings account shows us the economy is growing at a faster rate than the interest rate you receive on the money you put into a savings account. This doesn’t necessarily mean your money is losing it’s actual value, it just means this money won’t get you as far as it used to.
An example of the effect of inflation on your money.
Let’s say you put a quarter in your sock drawer in the year 1960, which would buy you one gallon of gas (I didn’t make this up, gas was really only 25 cents per gallon in 1960). Now, fast forward to the year 2017. You decide to withdraw the quarter you put into your sock drawer back in 1960 and use it to buy a gallon of gas. The problem is in the year 2017 the average price per gallon of gas is $2.35. Obviously, your 25 cents will not buy you a gallon of gas anymore. This is an example of the effect inflation has on your money.
Although I used gas as an example, the same could be said for food, housing, clothing, and virtually all other goods. You should now be able to explain to your grandfather why back in his day 25 cents was enough money to walk up hill both ways to the gas station to buy a gallon of gas, but now it’s barely enough to buy a piece of gum.
The advantage of investing your money.
Let’s take the same scenario above, but this time you decide to invest your 25 cents in the stock market. The average annual return of the stock market over time is 7% according to most sources. To simplify things, we will not take stock splits or dividends into consideration and we will assume you made an average return of 7% each year from 1960 to 2017.
Over the course of 57 years (1960 to 2017), your 25 cent investment would now be worth $11.83. Time to go out and buy a beach house, your investing has paid off! Maybe you can’t buy a beach house just yet, but you can buy about 5 gallons of gas. If you had merely saved the money in your sock drawer you couldn’t even buy a gallon of gas in 2017. As a result of investing you not only kept up with the rate of inflation, but actually surpassed it.
I know going from 25 cents to $11.83 doesn’t seem like much of a return, so let’s run the numbers with an initial investment of $1,000 under the same scenario. Using the the 7% annual return from 1960 to 2017, your initial $1,000 investment would now be worth $47,301.55. Now that’s impressive!
I personally think these calculations are fun to do. If you would like to run these calculations with your own numbers there are plenty of online compound interest calculators you can use.
If you would like to read more on the importance of investing early and some possible investment options to help get you started, check out this article: Invest Now For Big Returns Later
Investing is the key to future wealth.
Hopefully these examples have painted a clear picture on the advantages of investing your money and why you should start as soon as possible. Keep in mind that not all investments are created equal as some are more risky than others. It’s up to you as an investor to choose investments that align best with your investing goals and the risks you are willing to take. Happy investing!