Why should we start investing?
Hopefully you have been able to find your way around the website and the social media channels and I have already been able to provide some value to you. However, I can understand that all the information provided on different ways to invest can be quite overwhelming. Don’t worry, everything will become clearer soon. So let’s circle back to the start. Why should we even start investing? In this blog you will learn how to start building wealth while beating inflation and taking advantage of compound interest!
The idea of investing for most is this vague concept where the rich gamble away their money to get exceptionally high returns. This is not the case. In reality, investing is a way to put your money to work and is accessible for everyone willing to consistently spend less than they earn and grow their wealth. There are many goals that you can accomplish with investing. It could be that you would like to retire earlier, pay for your kids their education (or even better, buy a nice vacation home when your kids move out), never have to stress about losing your job or it could be a way to consistently be able to save your money otherwise spend. To easily summarize all of the above, we want to grow our wealth. So how does investing come into this? Let me explain…
The first step in growing your wealth is of course, spending less than you earn. In other words, having some money left at the end of the month. If this is the case for you, well done! You are already way ahead of most. However, saving up a few hundred dollars each month is good, but it is most probably not going to let you reach your financial goals anytime soon. Especially taking into consideration the fact that almost everything is getting more expensive due to inflation. Coincidentally, this is the first of the 2 main points as to why we should start investing. To beat inflation.
Inflation
If you have been missing the news the past year, here’s a quick summary of what inflation actually is: Inflation is defined as the loss of purchasing power over time. This implies that your money is worth less because consumer products increase in price. Inflation is measured in percentages (%) and differs per year. However, the long term goal and therefore a good benchmark to keep in mind 2%. This implies that every year, effectively, the money in your bank account is worth 2% less, due to all your expenses being 2% higher. When looking at recent times, in the end of 2022 inflation rose to 8%! This means that any amount of money in your bank account has lost 8% of its value and will continue to do so over the following years with fluctuations in the number.
This is where investing comes into play. The average yearly return of the S&P 500 index, i.e. one of the most prominent assets you could buy when investing, is about 10%. In order words, the money invested in this index will be worth (on average) 10% more each year. Of course, one year this could be 20% and other years it could lose 15%, keep in mind that we are talking about an average here. Look at it like this, while the saved money in your bank account loses 2%, 5%, or even 8% of its value each year, the money you have invested could gain +- 10% each year. As a result, you are growing your wealth exponentially. This is where main reason to invest number 2 comes from, compound interest.
Compound Interest
Compound interest, or as I like to call it, the 8th wonder of the world, is defined as interest over interest. Say you invest $100 at 10% interest (return), in a year you will have $110, an extra $10. The next year, you will receive another 10% interest over this $110, giving you $11. This is called exponential growth, meaning, the amount by which your money grows, increases every period you receive interest. In investing sense, the “interest” is the return you make on the assets you hold. This topic is arguably the most important topic of your investing career.
For some clarification, imagine 2 scenarios. Scenario 1 Bank Account and Scenario 2 S&P 500 index. In scenario 1 you would save up $1000 each year and put safely in your bank account. Doing some simple math, after 50 years you will have saved up $50.000. Easy right? Now imagine scenario 2, investing that $1000 with a 10% average yearly return. In this case, every year the money you have invested grows by 10%. After the first year you will have $1100, a gain of $100. After investing another $1000 and getting another 10% return, you will have $2310, a gain of $210. At this point, this seems like an insignificant difference. However, what if we look at year 50?
After repeating this process for 50 years, consistently investing $1000 yearly and getting that 10% return, you will have around $1.163.908. Yes, you have read that right. More than a million dollars. Quite a big difference to that $50000 right? Keep in mind of course that this the ideal situation where you are able to keep consistent for all these years and you actually get that 10% annual return. Even if you are able to invest $500 each year and you only get a 7% return, this will amount to around $200.000, quadruple the amount when just saving up your money! This example shows the sheer power of compound interest and why it is so important to be in the market as long as possible.
To conclude, whatever your goal is, it is likely that it will be beneficial for you to grow your wealth. By beating inflation and learning about compound interest, this is something which is achievable for everyone. Join us on the journey to financial independence and let me guide you along the way!
Want to learn more about investing? Check out this link!
Want to make these compound interest calculations yourself? Check out this link!!
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