Why should I think about investing?

You probably make small decisions about money every day: You buy groceries, shop online, and sock away money to pay the bills. But while short-term expenses are usually top of mind, they’re not the only part of your financial life — It’s also important to think about what’s on the horizon.

The decisions you make today can lay the foundation for a comfortable (and ideally, wealthy) life. Investing is one of the best ways to help you grow your money.

Investing is like gardening…

If you’ve ever tried growing your own tomatoes, you know it demands time and patience. Oftentimes, there are plenty of challenges along the way. From pesky insects and creepy-crawlies to choosing the right amount of water and type of fertilizer, there are many factors to consider. Over time though, as you start to understand what works, the fruits of your labor can be really rewarding. Even if you don’t have much to start, with consistency and care you could grow a strong harvest.

When you think about your future, how many of your plans require money? (Unless you’re Marie Kondo, probably a lot of them.) Would you like to buy a home? Send your kids to summer camp, or pay for their college? (Can you even imagine how much college might cost in 20 years?) Maybe you hope to travel, or start a small business? Odds are, you’ll need money to do any of these things, or whatever else you have in mind. Investing can help you get there.

Investing is also likely to play a big role in saving for your retirement. You might consider how long you expect to work, where you’d like to live, what hobbies you might pursue, and when you’ll be pushing up daisies. Investing is how many people build wealth, and prepare for goals both near and far.

Compounding has sometimes been called the eighth wonder of the world. So what is this incredible force?

Put on your gardening hat for a second. Let’s say you have one orange tree, and it produces the sweetest fruit you’ve ever tasted. Well, one tree is great, but you know what’s better? Two trees, or maybe an entire orange grove.

As your tree yields fruit each year, you might take some of those oranges and plant new trees. Year after year, you can nurture more and more saplings, and your small grove might grow, larger and larger. The same concept applies to investing (and reinvesting your returns) to generate compound growth.

To better understand compounding returns, you can try this calculator from Investor.gov.

When you invest, you’re not just stashing money in a small box, hoping it’ll magically multiply. When you buy a stock or an exchange-traded fund (ETF), you’re actually buying a piece of a business (or businesses). Depending on your exact investment, that might include some bonds or other assets, too. But in essence, you become a part owner. (That’s right, boss!) As a shareholder, you experience a company’s ups and downs, whether that means a handsome payday if it grows, or a decline in your investment if it falters.

You can probably guess the answer to this question — We’ve been through some tough times, including a pandemic and a big market drop. Realistically, many people just aren’t ready to start investing, and in many cases, young people are falling behind. While about 58% of Americans own some stocks as of April 2022, that number is much lower for young Americans. Indeed, among American millennials, nearly 60% have no stock market investments at all.

Fundamentally, investing is about risk and return. While a savings account can offer you a marginal interest rate, investing allows you to pursue a greater return over the long run. How does this work? Well, let’s look at the S&P 500 index, an array of stocks that represent some of the largest companies in America.

Over the last 32 years, the S&P 500 index saw an annualized return on investment of about 9.79%, assuming you reinvested all dividends. In other words, between Jan. 1990 and Nov. 2020, a $100 investment tracking the S&P 500 would have grown to about $2,147.89, before subtracting expenses and taxes. (Remember, past performance is no guarantee of future results, and all investing involves risk.) Still, the S&P 500’s annual performance has varied dramatically — For instance, the index rose 21.8% over 2017 and fell 4.3% over 2018. That’s just a sample of the fluctuations you might experience.

While the US stock market has generally grown over time, it hasn’t been a smooth or straight line. While sobering, this context can help you prepare for when markets get bumpy.

In order to understand the potential difference between investment and savings, let’s look at a hypothetical example, calculated over the course of 40 years.

Let’s pretend you’re 25 years old today and you plan to retire at 65. How could things look if you invest $100 per month in a fund tracking the general stock market?

For the sake of our example, we’ll imagine you started with an initial deposit of $1,200 and the fund you invest in grows 6% annually over the next 40 years. (We’re not going to consider dividends, taxes, or inflation.)

If you consistently invest $1,200 per year, and stick with the market’s ups and downs, your money could grow to nearly $200,000. By comparison, if you stashed the same amount in a savings account with an annual average of 2%, your overall investment might grow to just about $75,000. (If you adjust your investment amount, your rate of return, or the interest rate on the savings account, you can see how the gap might grow or shrink.)

Why the disparity? To put it simply: stocks are riskier. When you invest in a company, you’re pinning part of your financial future to that company’s performance — It may succeed, fail, or just stagnate. While savings are more stable (the bank uses your money to support other things, like mortgages and car loans), there’s just less growth potential.

Another major difference is that deposits at nearly all banks are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. One more key consideration is liquidity — i.e., How accessible is your money and how hard is it to sell your holdings at a fair market value? You have to decide what mix of savings and investment is right for you.

Your investments can grow in two ways: appreciation and dividends. Appreciation means that the value of something increases (you might remember hearing people talk about their home appreciating in value). The same applies to stocks — They can appreciate, meaning that their market value can increase. The opposite, or depreciation, is also possible.

Dividends are your cut of the profits. If you hold a stock and the company makes a profit, it might choose to return a little bit of that money to you (the shareholder). You don’t have control over whether the company actually turns a profit or if it distributes a dividend. It’s also possible that the company might reduce or discontinue its dividend, without notice.

If you’ve ever heard a stock described as a “dividend stock,” that usually means that investors see the associated business as a fairly stable company that pays a reasonably reliable dividend to its investors. It might not be the buzziest name on the block, but generally speaking, it’s a somewhat battle-tested, potentially older company.

We’ve discussed some types of investments that build wealth in different ways, and produce different returns. As a general rule, savings accounts are the least risky, followed by bonds, and then by stocks.

For that reason, most investors don’t pick just one type of investment. Instead, most people create a mixed basket (aka a diversified portfolio) to manage their risk, and by extension, to optimize their returns. Your portfolio might include funds that track indexes, individual stocks, bonds, and perhaps real estate. Remember, your portfolio is about building a combination that works for you and your specific goals.

A diversified portfolio is kind of like planting a big garden with a bunch of different fruits and vegetables. If the tomatoes don’t work out, hopefully, you’ll still have fresh strawberries, lettuce, and onions. And to think, when you started, all you had was a packet of seeds.

Disclosures

The examples shown are hypothetical and designed to illustrate basic financial concepts. As such, they do not represent any actual returns available now or in the future.