When building wealth, it is important to understand the similarities and differences between saving and investing your money. Knowing when to save and when to invest your money is a key part of your wealth building plan.
Let's start from the top. Basically, saving money is putting money aside on a regular basis. You spend less money than you earn and put the rest in a savings account at your bank. This should be an automatic part of your monthly budget. Remember, saving money is an important part of being financially successful.
Investing is taking this a step further, and putting money into the stock market by buying stocks, bonds, mutual funds, or other investment vehicles. Investing is absolutely imperative in building long-term wealth.
What Is Investing?
Once you have a good amount saved, you can begin investing money. Investing is the way that you will begin to really grow your money and begin to build wealth. For example, if you keep your savings in a savings account, the amount of interest you will earn will be very small. However, if you invest in mutual funds or stocks, your rate of return will be much higher.
The big difference? The stock market fluctuates, and it’s never a sure thing that you’ll earn money. In fact, you can lose money in the stock market, so be sure to keep that in mind when investing.
You will eventually come to the point where your investments make more than you are contributing each month. Your wealth really begins to grow at that point.
What Should I Invest In?
When you begin to build wealth, it is important to spread your risk. Mutual funds are an easy way to diversify your portfolio. These funds are spread out over many different stocks so that if one company fails, you do not lose everything. Another good idea? You should have your money invested in more than one mutual fund. You don't need to have 20 mutual funds, but three or four is a good start.
If you feel confident with investing in individual stocks, be sure that you spread your investments over a wide variety of companies, businesses, and sectors of the market (For example, do not invest all your money in tech.) It is not enough to invest in different companies if they are all in the same industry because sometimes entire industries can take a hit.
You may consider investing in other things. One example is real estate. This can bring you a good passive source of income. Real estate also tends to increase in value over time. However, do not do this until you are ready to purchase in cash, and can pay for any repairs or unexpected expenses out of cash flow. It also may require more work on your part, depending on how you choose to rent it out and whether or not you use a property management company, which can cut into your rental property earnings.
Real estate can be a great investment, but it also has its risks. Much like the stock market, property values can go up and down.
When Should I Start Investing?
Most financial advisers recommend that you wait to start investing until you have paid off the majority of your debt. However, this really depends on your interest rate. If you are paying a 0% interest rate on your debt, it may make more sense to begin investing before it’s paid off, since you can earn a greater percentage in returns. (The average rate of return on the stock market is around 7%.)
It’s also a good idea to have a solid emergency fund saved before you begin investing. You should have money in your emergency fund that relatively liquid and easily accessible, without paying a large penalty. A money market account at your bank is a safe place to put this.
Investing can help you build wealth. But keep in mind that you won’t be able to truly build wealth – and increase your net worth – until you spend less than you earn and get out of debt. That's why it’s still wise to stick to a budget, so you can save and invest effectively.
Who Can Help Me Start Investing?
So you’re ready to invest, but you’re not quite sure where to start. A good first step is to meet with a financial advisor.
A financial adviser can explain the different types of investments that are available to you. He or she can explain the risks and the potential gains to help you find investments that you are comfortable with.
Another option is to select an online brokerage site or robo-investor. The fees are lower and if you know the types of investments you want to make, you can save money in the long run.
One final thing to keep in mind: Investing is a long-term strategy for building wealth. It’s important to be patient, and ride out the times when the market is not doing well. Once you do this, then you can truly be on your way to building net worth.
Updated by Rachel Morgan Cautero.