Remember that easy to understand personal finance class you took in school—the one that clearly lays out how to save and invest for a secure financial future?
Despite taking a lot of finance courses and getting my CPA, when I graduated from college I didn’t really know much about the practical aspects of investing. When I got my first job I was a little slow getting my investing life in order (including ignoring the fact that my company offered a great retirement plan).
But, apparently I was not alone. According to a recent Bankrate survey, less than half of American adults have invested money (including investments in retirement accounts). And I can understand why: After the financial meltdown of 2008, it can feel a little scary. Investing is not a topic emphasized in school, so it can easily be seen as confusing and overwhelming.
In future articles I’ll lay out easy strategies to start investing, but first we’ll cover exactly what investing is and why it’s important to get started sooner, rather than later.
What is investing?
First off, investing is not saving. While saving money is a necessary, extremely important, and responsible thing to do, putting money away each month into your savings account isn’t investing. Saving is for short-term goals (like a house down payment or emergency fund) and should be kept in a safe place like a FDIC insured bank account.
At its basic level, investing is making money work for you. Whether you choose to invest your money in stocks, bonds, or back in your own business, the goal of investing is to have your current money make even more for you. Investing does come with the risk of losing money, alongside the hope that over time you will have long-term gains. With that in mind, investing is best for long-term goals, like retirement.
Why should you start now?
Everyone in finance loves to talk about the power of “compounding”—it’s a term thrown around a lot. But what exactly is it?
Compounding is the process of creating more money on your re-invested earnings over time. So let’s say that you invest $5,000 today and you earn 6% on it. At the end of year one you’ll have $5,300. You leave the $300 that you earned in and don’t invest anything else in the second year. After one more year of earning 6% you will have made another $318, with a total of $5,618.
While it may not seem like that big of a deal, when you let your money compound over years (and years and years) that seemingly small extra amount adds up. But the key is to start investing as early as possible—when time is on your side—so you’re able to take full advantage of the power of compounding.
One of my favorite examples to illustrate the power of starting early is looking at the difference between starting to invest at age 25 or at age 35. Let’s say that starting at age 25 you invest $1,000 a year until you’re 60 and it earns an average of 6% per year. When you turn 60 you would have $127,443.
Now let’s say that you don’t actually get around to starting investing that $1,000 per year until age 35. You invest $1,000 per year until you’re 60 (25 years) and it earns an average of 6% per year. When you turn 60 you would have $62,503.
Think of the difference that could make in your retirement! By starting 10 years earlier, your money compounds for 10 years longer and you end up with an additional $64,940.
Bottom line? Start now.
In my next article we’ll discuss easy ways to stop procrastinating and start investing so you’re able to take advantage of the power of compounding.