Most financial websites and blogs discuss the importance of saving money, but not enough attention is given to investing it – investing your savings is a requirement in today’s world if you are really going to build substantial wealth and have your savings grow and multiply.
Of course, saving money is the first step to building wealth
No one in their right mind would deny the fact that saving a substantial portion of your income or earnings is the first step toward building a secure financial future and building wealth. Without actually being able to save, you’ll have no money to invest in the first place – without saving your life will always be a paycheck-to-paycheck type of existence.
However, saving alone won’t get you to where you want to be. If you’re earning an income and putting money away diligently, you won’t get the full benefit of that savings unless you invest that money prudently. The main reason for this is that when you invest, you’re no longer relying on your own labor to earn income but are instead able to have your money work for you.
Investing Allows Your Money to Work Hard for You
By investing you are taking your savings and allowing it work for you. This sounds like a simple concept, but too many people don’t understand how important it really is.
Investing allows you to take advantage of compound interest/returns– this is one of the most magical things about finance and the world in general. Compound returns allow the returns of Year 1 to be reinvested in Year 2 in order to have more capital with which to work with. The same thing is done in Year 3, Year 4, and so on. The magic of compound returns doesn’t really present itself in the first few years – it takes some time for the accumulated returns churning over and over to really add up to a big difference.
Here’s a relatively simple example for you to understand how powerful compound returns really are. Imagine the following situation:
- two brothers start a full-time job at 25
- both brothers save $5000 per year
- one brother invests his money (at a 10% return) while the other does not (and earns no return)
NOTE: Obviously, the brother who doesn’t invest might still earn some small interest via a savings account or a CD, but we can safely ignore this by assuming that both numbers — the 10% return and the 0% return — are post-inflation numbers where the non-saving brother ends up exactly even after accounting for inflation.
Now, where will these brothers end up after 30 years? Taking a look at the table we’ve created below, you can see that after 30 years the non-investing brother will have $150,000 while the investing brother will have $822,470.11 – this is a substantial difference in final amounts especially given the fact they these brothers saved exactly the same amount each year.
Two brothers – one who invests his savings while the other one does not – have vastly different outcomes after 30 years of consistent saving
This is a clear example of the magic of compound interest or compound returns – the investing brother doesn’t just depend on his ability to scrimp and save but instead is able to earn money on his money.
Clearly this example demonstrates how important the return earned on your money is to your future wealth – the greater the return the greater the compounding you will achieve. You should obviously be mindful of risk when investing, but keeping in mind the fact that return is a fundamental part of the equation will serve you well when you are thinking of what to do with your savings.
Thinking About the Future – There’s No One Coming to Save You
Unlike generations past, there’s no one coming for many members of Gen X and especially Gen Y/Millennials – these generations are going to face the serious risk of Social Security not being around during retirement. Compound that with the fact that pensions are at an all time low with most jobs — including high-quality full-time jobs — not offering any sort of pensions. This means that savers are left with things like a 401k (which doesn’t provide guaranteed income like a pension), IRAs, Roth IRAs, and post-tax investment options.
Fundamentally, the US has transitioned and is continuing to transition from a guaranteed-benefit retirement world to the world where savers and investors must rely on themselves. Keeping this in mind, it is absolutely crucial for savers to invest their money so that it can grow into a nest egg big enough to support them and their families through retirement and hardship. Think of the non-investing brother above: Do you think he will be in a good place facing retirement with only $150,000 in savings at age 54?
Author Bio: Levon writes for Pennies and Pounds, a blog that attempts to help readers with personal finance, investing, income growth, career development, and personal growth. His writing seeks to assist readers with developing a disciplined, rigorous, and effective approach to their overall financial well-being. Levon has been investing since he was 18 years old with a consistent market-beating track record. He holds a BA in Economics and an MS in Financial Engineering.