Investing is a crucial aspect of wealth building that many people often overlook.
You may not be investing for many reasons. But most of them are based on false beliefs.
Reasons Why People Don’t Invest
- Lack of knowledge: You may think that investing is too complicated or requires specialized education. In fact, investing can be made very simple, that anyone can learn, by investing through index funds. Buy one or a few funds, and just wait for your money to grow.
- Fear of losing money: You may be fearful of losing your money in the stock market. In fact, proper investing balances risk and reward to make the probability of losing money in the long-term almost 0.
- Belief that you don’t have enough money: You may think that you need a large sum of money to start investing. In fact, starting early, even with small amounts, can add up to large sums years later, because of compound interest.
- Misconception that it’s like gambling: You may believe that investing in the stock market is like gambling, believing that it’s primarily based on luck. In fact, proper investing is based on logical time-tested principles.
Why Savings Accounts are Not Enough
If you only save money in a bank, you will earn low interest rates, likely from 0-5%.
This means your money will grow over time, but slowly.
Unfortunately, you also have to consider inflation.
Inflation is the general rise in prices over time, typically averaging around 2% per year.
This means that the average cost of living increases over time.
Equivalently, this means that your money loses purchasing power by about 2% per year.
If you save at a 2% interest rate, but inflation is also 2%, then your return after inflation (called your “real return”) is 0.
This is the modern equivalent of stuffing your money under your mattress.
Why You Need to Invest In the Stock Market for Long-Term Wealth
Investing in the stock market allows you to earn a positive real return on your savings.
Investing is a proven method to build wealth:
- Long historical track record. Since 1900, global stocks have had real returns of about 5-7% per year on average.
- Compound interest. The power of compound interest allows your investments to grow exponentially over time. This means that over time, your wealth grows at an accelerated rate.
- Passive income. Investing is one of the few true sources of passive income, because it provides income while also not requiring much effort.
Historical Returns
Investing has a long historical track record.
In the long-term, the global stock market has had an average nominal return of about 7-10% per year.
Similarly, global stocks have had real returns of about 5-7% per year on average.
In general, a good guideline is 8% nominal growth, or 6% real growth.
This return is consistent over the long-term.
Compound Interest
Compound interest is when you earn interest not only on the initial principal amount that you start with, but also on the accumulated interest from previous periods.
- “Money makes money. And the money that money makes, makes more money.”—Benjamin Franklin
Investing in the stock market involves compound interest, because your returns can be reinvested and generate more returns over time.
This is also called compounding returns, exponential growth, or the snowball effect.
This is the same concept that applies to interest in a savings account. However, it is more useful in the stock market, because of the higher average rate of return (8% for stocks vs 2% for savings).
[Include stock market chart for the last 100 years].
Investing is One of the Few True Sources of Passive Income
Investing is one of the few true sources of passive income.
Passive income is money you earn without actively working for it.
It includes interest, dividends, and capital gains from your investments.
As your investments grow, your passive income increases, which reduces your reliance on active work to support your living standards.
The Purpose of Saving and Investing
Previously we talked about a few reasons why investing is important for long-term wealth.
A more foundational question is: What is the purpose of investing money?
The primary purpose of investing is to consume in the future.
When you have more money, either you can:
- Increase your living standards
- Decrease the amount of time spent doing work you dislike
By setting aside money for investments, you are essentially creating a nest egg for significant life events such as buying a home, funding your child’s education, or covering your living expenses during retirement.
This could mean affording better opportunities for you, your family, your partner, your children, etc.
It also could mean retiring early.
If your investments can generate income, this means you have to generate less active income with your job to achieve the same standard of living.
As you get older, this will lead to a secure retirement, that allows you to enjoy the fruits of your labor.
You may even be able to retire early. This is called financial independence retire early (FIRE).