People talk about investing money all the time. Since money doesn’t grow on trees (although that’d be cool if it did), you have to work for it. And you need to work very hard. So why not leverage the art of compound interest and passively invest your money for the future?
Do you expect to live off of your social security income primarily? Or would you prefer to have a safety net? Investing shares a level of importance in our lives, though every one of us may prioritize it slightly differently. The keyword, though, is important. Investing provides a proportion of financial security, serving as a warrior battling in the fight against inflation.
What does that mean? To understand financial security, let’s learn more about investing and how letting your money work for you can provide you with wealth.
What Is the Difference Between Saving and Investing?
One would think that the terms saving and investing are the same, but not. They have different meanings. First, let’s look at what it means to save money.
Saving Money
When you think about saving money, what comes to mind? How about putting it aside or storing it for use at another time? Saving money is tied to a short-term goal, such as buying a car or a deposit for a house. It’s even a great option for a rainy day fund.
Saving money is more secure than investing it. For example, the FDIC insures up to $250,000 in a bank account. It’s also accessible through an ATM or a bank teller during operating hours. It also occurs before investing. Here are two reasons why:
- It’s best to have three to six months' worth of living expenses set aside in case of an emergency before tying it up into investments that may or may not be liquidated if needed.
- Putting aside your money to pay off debt ultimately frees your cash flow. Once the debt subsides, you’ll have more to either save or invest without financial obligations holding you back.
Investing Money
Now, what do you envision with investing? Investing is associated with long-term goals and growth. To grow money, you need to apply it against an asset that has the potential to increase in value over time. Examples of investments include stocks, commodities, exchange-traded funds (ETFs), and more.
Investments carry baggage or risks. There’s no stamp of guarantee that your money will double, triple, etc. There’s always a chance it can devalue depending on how the market performs. The risk is accessible, though, and you have control over where your money goes.
Repeat what we are about to tell you when investing your money: Consistency is the key to success. Keep your contributions regular. Here’s an option, have your money directly deposited to your investment choice. Out of sight, out of mind.
Why Should You Invest Your Money?
Many of us take comfort in opening a savings account at a local bank or even an online one. It starts off with a simple application that, within minutes, leads to your active account. But does it truly build your wealth over time?
If it is a typical bank savings account, no. It most likely yields a low-interest rate that won't add extra value unless you have a large sum of cash deposited. This is especially true during times of inflation. On the flip side, it’s a great account to tuck away those emergency funds for unforeseen expenses.
When you invest your money, you ask that it grow at a rate to build your wealth. This is accomplished through the concept of compound interest.
The Power of Compound Interest
Compound interest is life-changing, especially once you’ve mastered the art. History tells us that Albert Einstein actually considered it the eighth wonder of the world! Let’s explore how it works.
Simple interest is earned on the principal balance of the account. On the other hand, compound interest is earned on the principal balance plus interest earned.
The process continues, round and round in a circle, growing your money and compounding your return. It also works adversely should you have credit card debt.
When Should You Start Investing?
When you are younger, you can put away smaller amounts of money while the accounts work on your behalf. Fast forward as you age, you’ll need to deposit large amounts of money and may potentially lose out on some financial gains along the way.
What Are Your Investment Options?
Many investment options exist. Some use compound interest; others do not. Here are a handful of examples:
- 401(k) and 403(b)
- IRAs
- High Yield Savings accounts
- Certificates of Deposit (CDs)
- Real Estate Investment Trusts (REITs)
- Bonds
- Stocks
- Commodities
Let’s highlight a few of the examples above in more depth below. You don’t have to settle for one investment option on a positive note. It’s recommended that you diversify your portfolio to mitigate your risk level.
If you can, spread the wealth and meet the caps of different types of funds that’ll work to your benefit over the years.
401(k) and 403(b)
401(k), or 403(b) for not-for-profit organizations, are a common investment fund set up through employers that grows your pre-tax contributions.
You’ll have the ability to choose a mutual fund designed with options tailored to your targeted age of retirement. If you are up for the challenge, though, you should have an option to select the specific stocks, bonds, and other securities as well as weigh them in your portfolio.
For 2022, the IRS announced the annual contribution to a 401(k) or 403(b) is capped at $20,500.
Individual Retirement Fund (IRA)
An IRA is another option for investment. You have the option to choose a traditional IRA or a Roth IRA. The difference? The type of contribution and how the withdrawals are handled when disbursement.
If you want to stick with pre-tax contributions, then the traditional IRA is the best choice; however, if you don’t mind paying taxes upfront so that future withdrawals are tax-free, then a Roth IRA may be better.
In 2022, the contribution remains unchanged, capping at $6,000 per year for each type of IRA.
The Pros and Cons of Investing in Commodities
Commodities are used to diversify investment portfolios, acting as a strong hedge against inflation. Examples include:
- Gold
- Crude oil
- Other metals such as silver, aluminum, palladium, and more
Especially when thinking about precious metals, it may be hard to picture carrying around gold bricks or coins if you don’t have a lot of storage space around the house.
Yes, it is still an option if you prefer to have a tangible product to look at and admire, but commodities are also purchased through other methods. This includes exchange-traded funds, stocks, mutual funds, and futures.
One downside to commodities is their volatility. Supply and demand play a huge role in the price of commodities.
Secondly, commodities do not pay interest or dividends as other forms of investments do since they are not income-generating. Because of this, it’s more about the quantity you own.
Overall, demand is at large, keeping the prices competitive with the capability of having favorable returns.
The Bottom Line - Don’t Wait To Invest, Start Now
Remember that saving and investing are not the same thing and serve different purposes, the former set-up for short-term goals and the latter for long-term.
Don’t let investing frighten you. Sure, it comes with risks, and it can be intimidating if you don’t understand how to play the game, but that shouldn’t stop you.
Seek out a professional advisor, if needed, to educate you and get you started. If preferred, you can always take the wheel once you gain confidence. Set your financial goals and start investing your money for the future.
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Sources:
What Is Compound Interest? – Forbes Advisor
Types of Investments | FINRA.org
Saving vs. Investing – Wells Fargo Advisors
IRS announces changes to retirement plans for 2022 | Internal Revenue Service