I graduate next year, so the time is fast approaching when I will have to start “adulting” a little better. I know that a big part of that is going to be taking care of my personal finances. I’ve had a summer job since high school, so I know a little bit about working and saving money, but I don’t know everything that I think I should. One that that bewilders me is investing. It makes me nervous, to be honest. When I see the stock ticker things on the news, it all looks very complicated to me. I don’t like the idea of trusting my money to some complex system after I’ve worked so hard for it. I know you can make more money by investing than you can by just saving, but I’m tempted to put what I save into a saving account instead of investments. Is that such a big mistake? Do all adults invest, or is it more of an optional thing?
There are many various aspects of what you’re asking, so let’s unpack things a bit. First, we’ll address some of the basic facts about investing and why people do (or don’t) do it. Then, we’ll talk about whether you should invest, as well as about how much you might want to invest and how you might go about doing so without exposing yourself to undue risk.
First things first: all adults do not invest. In fact, a great many adults do not. Just over half–54%, to be exact–of Americans own stock. However, does this mean that 46% of Americans are making a conscious decision not to invest because of the risks and other factors that you mentioned? That’s improbable. Just because we can say something about the financial status of a lot of Americans doesn’t meant that that something is good, or even something those people do on a voluntary basis. Many Americans have nothing saved for retirement, and most experts agree this is a terrible thing.
Stock ownership tends to be more common among wealthier people. For instance, the richest 10% of Americans own 84% of all stocks (all the stocks owned by Americans, that is, of course). Non-owners of stock tend to be younger, less wealthy, or both.
Some stock owners (and bond owners, too) track the market with care, and make complex decisions. However in other ways, the culture of investing is something that looks a lot more complicated than it is. For instance, did you know that the market goes up over time? Did you know that that there are investment vehicles (“investment vehicle” is just a fancy term for “something you can invest in,” like a stock, a bond, or–in this case–a fund that collects other investments within it) that track the performance of the market as a whole? For some people, investing is as simple as buying shares in an “index fund” that tries to track the market. These investors buy, but don’t sell–they just sit on their investments and cash out years and years later, ignoring those day-to-day complexities that have you worried.
So, while not all people own stocks, the wealthiest ones tend to do so. That’s because they know that stocks will help them grow even wealthier. While stocks and bonds can seem complex, there are simple ways to invest. In short, investing is a clever idea that can be very easy–if you can afford to invest, you should!
Now let’s talk about the reasons behind all this. Here’s why investing is important in the first place.
As you may know, we all deal with something called “inflation.” Inflation means that the value of our currency goes down over time as prices go up, or “inflate.” That’s why people years and years ago bought candy bars for five cents, while we pay a couple bucks for similar ones!
When it happens at a reasonable pace, inflation is not a huge deal for our economy. However, it does have consequences for our savings. A dollar we earn today will grow less valuable, so if we stick it under our mattress (or in a low-interest bank account, like a checking account), we’re letting it waste away a bit. There is an antidote, though: interest.
Move that dollar from a checking account to a savings account, and it will earn interest over time to offset inflation. Interest is powerful when you let it compound. Here’s what that means: imagine you have a dollar in a bank account and let it earn interest. Let’s say you earn 10% (that would be very impressive, but this is just an example!). Your dollar is worth $1.10 now, and you can pull that ten cents out and spend it each year. Or–if you’re smart–you might leave that 10 cents in there, so that next year’s interest is 11 cents instead of ten. Over time, your growing principal will make your interest earnings bigger and bigger! That’s the power of compounding interest.
In a savings account, your money will earn interest. However, the reason that investments are so appealing is that their returns beat savings accounts a lot of the time. That makes sense–after all, saving accounts are low-risk, so stocks should offer better returns if they want us to risk our hard-earned cash.
Now we understand that investing earns us interest at good rates, and we know that compound interest is a powerful tool for building wealth. We know that wealthy folks tend to invest, and we know that investing isn’t always as complex as it seems. Now, let’s talk about you!
As you know from your own personal finance experience, we should all have some cash on hand in accessible places. Investments don’t qualify, so make sure that you have an emergency fund somewhere like a checking account. However, we also just learned that checking accounts don’t offer great interest, so it’s a promising idea to have excess cash somewhere else–like a savings account, for instance. For cash you think you can live without for now, you should look at long-term places to stash it–and investments are a place on which you should focus.
If you’re interested in investing in a safe manner for the very long term–we’re talking about things like retirement savings, here–then you should be looking at things like index funds. Index funds, which may be mutual funds or exchange-traded funds, try to track market indices: for instance, the S&P 500 is an index that tracks the progress of the 500 largest companies on the stock market, and an S&P 500 index fund would simple own those stocks and try to mimic the behavior of that index. If you invested in one of those, you could check on your portfolio just by looking at the S&P 500, which is one of those numbers on the news stations that confused you at first.
A very important thing in investing is diversity–that’s how we lower the risk that you were concerned about. With diverse investments, you can weather problems faced by individual companies and their stocks. Index funds have diversity built in, of course, but you can also diversify with specific stocks, or by investing in bonds and other investment vehicles as well as stocks.
Investing can be simple, but you can make it as complex as you want! As you get more comfortable, you may want to play around with some of your money, trying out a trading strategy or two or getting more aggressive and less concerned with avoiding risk. Just remember the basics, and don’t get risky with more than you can afford to lose. You might decide to keep your retirement funds in safe spots while trying to grow your wealth by risking a certain part of your extra cash.
How you choose to invest is up to you. Not everyone invests! However, the experts agree: if you can afford to invest, you should do so in a sensible manner. Investing is the most powerful tool the typical person has for growing wealth.
“An investment in knowledge always pays the best interest.” – Benjamin Franklin