Why Invest?
Now that you’ve created a savings plan and started setting aside money for future use, you’re ready to take the next step by putting that money to work growing for you. Instead of only using your time and effort (i.e., working) to earn money, you can invest some of the money you’ve saved and have those investments make money for you.
Investing means putting your money into something like stocks, bonds, real estate, or a business with the goal of making more money over time. By making smart investments, you can increase the value of your money faster than inflation so that you have more purchasing power in the future than you do today, building a more secure financial future.
Here are a few videos and articles that describe the benefits of investing and why it’s important to start early.
The Difference Between Saving and Investing
This two-minute video from Khan Academy provides a simple explanation of the difference between saving and investing, and why both are important.
Why Do I Need to Invest?
This five-minute video from a company called Personal Finance Club explains why it's important to invest and the growth potential of investing in the stock market vs. a savings account.
Growth Rate of Stocks vs. Bonds vs. Inflation
Historically, the US stock market has grown about 10% per year while the US bond market has grown 5% annually compared to inflation of 3%. One common measure of the US stock market is the S&P 500, an index of the 500 largest publicly traded companies in the United States. According to Investopedia, the S&P 500 index has grown at an annualized average return of 10.26% since its inception in 1957 through the end of 2023.
When different growth rates are amplified by the power of compound growth over many years, the results can be significant. To help visualize this, the graph below shows the growth of an initial investment of $1,000 at different growth rates over a 40-year period. If we assume a 3% inflation rate, similar to the average over the past hundred years, we see that in 40 years it will take $3,262 to equal the same purchasing power as $1,000 today.
Note that a 2% savings account would not even keep up with inflation growing to only $2,208. The 5% annual return for bonds does stay ahead of inflation, growing to $7,040 over 40 years, but the difference between stocks and bonds when invested over many decades is significant. That same initial $1,000 when invested in the stock market (for example, in an S&P 500 index fund), assuming a 10% annual return, would grow to be worth $45,259, almost 15 times more than inflation and 6 times the return of bonds.
The Power of Compound Growth
This five-minute video from Personal Finance Club describes the power of compound growth and starting to invest early.
Key Takeaways
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Growing your investments faster than inflation is really important to growing the value or purchasing power of your money. Keeping your money under your mattress or even in a checking or savings account will not grow your money fast enough to stay ahead of inflation.
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Time is your friend, so starting to invest early in life is a key lever to growing wealth over time. Notice that the curves in the chart are only a little different at 10 or 20 years, but turn into large differences when compound growth happens over 30 or 40 years. It’s powerful to start investing in your 20s and 30s, even if you start with only a modest amount.
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What you invest in matters. The additional growth resulting from investing in stocks, assuming a 10% annual growth, compared to bonds at 5% is enormous when compounded over 40 years.
Summary: Why Invest and How to Get Started
The first 10 minutes of this video from YouTube influencer Ali Abdaal describes why it’s important to invest to beat inflation, a variety of investment alternatives, and why investing in stock market index funds is a simple and effective way to get started.
Action Plan
Now that you’ve read and listened to some reasons to consider investing, here are the next steps to get started.
1. Confirm that you’re ready to begin investing. Remember that if you’ve saved money that you will need in the near term (e.g., an emergency fund or savings to buy a car), it should be held in a safe, easily accessible place like a money market account or high-yield savings account. This is called short-term or “liquid” savings. The part of your savings that is available to grow for long-term goals like retirement is the money you want to consider investing. The reason is that investing in stocks, bonds, and real estate involves risk, where the value of your investment can go up and down in the short term, but over the long term is likely to grow much faster than a savings account or inflation.
2. Proceed to our module Investing 101 to learn more about how to invest.