If you are a young professional, there is a good chance your job has a retirement plan. Since I work for a non-profit organization, my retirement plan is called a 403b, but it is very similar to a 401K that many other companies offer. Even though I am decades away from retirement and could use even more cash to pay for things now, investing, especially investing for retirement, is a necessary sacrifice that I’m making right now. So should you.
Investing will allow me (and you) to:
-increase our net worth
-build wealth
-pay down debt sooner
-provide a better life for our family
-live a better lifestyle
-become less dependent on our job
-have financial security when we are no longer able to work
Contrary to popular belief, most of us cannot just save our way to retirement or to a better life. Saving money is important, but it is not enough.
The interest rates in savings accounts are too low (so our money doesn’t increase much just sitting in a savings account) and inflation is too high (which means the price of things goes up each year). This means money made today is actually worth less than many made tomorrow because you can’t buy as much with it. Given these two principals, it is vital that you invest money. Let me give you an example.
Let's say person A makes $60,000 a year and decides to merely “save” 10% of her income each year (which is $6,000) in a savings account. Let’s say person B makes the same amount of money but instead decides to “invest” $6,000 (through his work retirement plan or Roth IRA) in stock market index funds which earn an average of 10% in interest each year.
After 10 years, Person A will have $6,000 x 10 years = $60,000 saved.
According to Table 1 below, after 10 years Person B will have a total of $95,624.55.
Person A contributed a total of 60,000 and didn't make any money in profits. Person B contributed the same amount of money ($60,000) and made over $35,000 in profits after 10 years. Person B now has $30,000 more than Person A by choosing to invest money instead of just save it.
If this trend were to continue for another 10 years, this difference would be even larger. Person A, by continuing to keep the money in a savings account, would have $120,000. Person B, by continuing to invest in index funds that earn an average of 10% in interest each year, would have $343,650. Nearly 3x as much money!
As you can see from this example, investing is critical to building wealth!
It is so critical that once you have a certain amount of money in an emergency fund, you should start investing money, even as you try to pay down debt. If you wait until you are completely debt free to start investing, you may be delayed in investing by several years and would thus miss-out on years worth of extra profits.
Thankfully, there are many different ways you can invest money. Some people invest in real estate, others invest in their own business. But as I’ve shown in the example above, one of the most popular ways to invest is in the stock market. Some people purchase stock in individual companies, but I prefer to purchase index funds, which are large groups of stocks from many different companies. Index funds earn an average of 10% in interest each year, which is what I used in the example above. Getting a 10% profit on your money each year will add up over time.
Although you may choose a different type of investment keep in mind that certain investments and accounts may cause you to make more money than others, some may pose a lot more risk than others, and some may require you to pay more taxes than others.
One of the simplest and tax-efficient ways to start investing is to open a Roth IRA or contribute to your work-sponsored retirement account (which is a 401K, 403b, or 457). Once you determine which account to use, decide how you want to invest the money in that account. I purchase stocks and bonds via index funds, but you can choose what is right for you based on the options your job has available. The important thing is that you start investing money now so that you can become more financially stable and start to build your net worth over time. While saving money is good, investing money is better.
Tell me, have you started investing money? If so what investments are you making and what type of account are you using?