Investing is simply the practice of allocating money or other resources into places it can grow in the future. The days of depending on the interest from a bank savings account have long been over as the average interest rate is under 1%.
Earning interest from a certificate of deposit (CD) or money market account doesn’t push the return much higher and, in the case of a CD, comes with restrictions on how much and how long money can be left in the account and the interest that can be accrued. Conversely, money market funds can be opened for as little as $1 with no monthly fees attached.
As a result of low returns from our “safer” investments, it’s important for younger students to broaden their perspectives to include what used to be considered risky investments such as equities (stock market). The key is learning the difference between investing and speculating, which is ultimately determined by your understanding of the world.
To understand some of the risks, historical context is required. One of the strongest indexes in today’s market is the Standard & Poor’s (S&P) 500, a group of the largest U.S. companies from the New York Stock Exchange and the technology-rich Nasdaq. Since its inception in 1926, the S&P 500 has produced an average annual return of about 10%. So, in other words, an investment of $5,000 would result in a yearly profit of $500 in the first year (and grow from there).
Some older investors (more so speculators) have been wary of the stock market because of its ups and downs. But the facts are that, in most years, stocks will rise rather than fall. That has been particularly true in the last 20 years. Only four times in the last 18 years has the S&P 500 declined in value with the worst year being 2008 during the last recession in the U.S.
It is important to draw the distinction here between investors and speculators. An investor generally believes in some underlying fundamental and is in it for the long-haul. Price fluctuations matter little for someone who views the world in this way.
And, investors are generally rewarded.
Take our example of the initial investment of $5k above that generates 10% annually. When we plug this into a compound interest calculator, we can see that in 10 years, your total invested funds swell to $12,968.71.
But the real magic happens when you mix the habit of saving with investing. Imagine now, that you were able to contribute $100 per month in addition to your initial investment.
If you were able to hold-out, delay gratification, and re-invest your profits, in 10 years, you’d have $32,093.62.
Can you save $150 per month? That gets you to $41,656.08.
Did you see that?
With just such a small change in a monthly habit (saving $50 extra), you were able to add nearly $10k to your future income.
The market (and life) rewards positive habits such as these.
Speculators, in general, have not developed some of the habits outlined above. They are in it for the “quick flip.” Some maybe skeptical and outright suspicious of the market.
Crashes and other unfortunate events generally mark the worst (if not the end) of such individuals, as they rush to pull out what little money they have left.
BUT, because they’ve just pulled out, compound interest and appreciation both stop, and they miss out on all the future gains that would have balanced out their returns.
Remember, that 10% figure above was an average rate of return. Some years might be lower, some higher. However, if you forget your strategy (your habit of investing a set amount of money weekly, monthly, or quarterly) and sell out due to fear, you automatically cut your future earnings.
Also remember an important quote: “It’s not ‘timing’ the market, but ‘time in’ the market. In other words, don’t try to “make a quick buck,” but stay the course, and let compounding do its thing.
It should also be noted that the level of risk can be lowered by balancing your portfolio with various types of index, mutual, and exchange traded funds (ETF’s) rather than buying individual company stocks. Some mutual funds invest partially in bonds which often go up when more aggressive growth stocks are down. Keeping your portfolio balanced is critical in achieving your investment goals.
There are plenty of financial institutions that have long excellent track records such as Vanguard, Fidelity, TD Ameritrade, Merrill Lynch and Charles Schwab, which provide customer service and many online tools to wisely manage your assets. In addition, some new kids on the block like Robinhood and Webull have become popular recently.