Why Is Investing Important?

Investing is not just beneficial, it is necessary for retirement

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Not everyone saves for retirement, and even those who do may not be putting away nearly enough to last through the retirement years. A 2020 Federal Reserve study showed that about 25% of non-retirees were not saving for retirement. However, everyone needs to invest to create wealth, beat inflation, and save for retirement and other financial goals.

Investing does not need to involve saving large sums of money. Due to compound interest, you can earn money on your initial amount invested plus all the accumulated interest from previous periods. While everyone should be investing, each person has a different investment strategy that fits their personal and financial goals.

Learn what investing is, how much money you should invest, different investment strategies, and where to begin when investing.

Key Takeaways

  • You do not need a lot of money to begin investing. Even small amounts of your money can earn money faster due to the power of compounding.
  • Investing can help to create wealth, meet financial goals, beat inflation, and save for retirement.
  • One investment strategy does not fit everyone. Your investment choices will differ from those of your friends and family.
  • Your investment strategy depends on your financial situation, how much risk you are willing to take, how long you hope to invest, and other factors.

What Is Investing?

Investing is the act of purchasing assets or goods with a goal of generating income and appreciation. Investments, which are assets or goods purchased, are used to create future wealth. Often, these goods are in the form of stocks or bonds, but can also involve real estate or alternative assets such as cryptocurrency or gold.

Why Should You Invest?

Investing your money is important for a few reasons. You want to create wealth to help during times of need, job loss, or for future goals. You also want to take advantage of compounding while taking into consideration inflation, so your money is not worth less over time. In addition, if you plan on stopping work at some point and retiring, investing is important to help you achieve those goals.

Let’s examine a few of the reasons why investing is so important.

Wealth Creation

Wealth could mean different things to different people. It could mean a certain amount of money in your bank account, or it could be defined as certain financial goals you set for yourself. Either way, investing can help you get there.

If your aim is paying off debt, sending your child to college, buying a home, starting a business, or saving for retirement, investing can help you reach those goals faster than money accumulating in your bank account.  By investing, you can build wealth, which is the increase in value of all of your assets.

Wealth creation is not just a goal that may help you through your lifetime. You can leave behind a financial legacy by building generational wealth through investing. Generational wealth can not only provide strong financial footing for your children, but may be a step toward bridging the wealth gap faced by many communities.

Compounding

With investing, you can take advantage of compound interest.  Compound interest is the interest you earn on your invested money plus the money earned in each prior period. It is sometimes called “interest on interest.” Compound interest allows you to grow your wealth quickly. For example, if you invested $50 a month for 15 years, your total contribution over that period would be $9,000. Assuming a 10% rate of return, that $9,000 would grow to over $19,000 in that period thanks to compound interest.

You can visualize different scenarios of how your money would grow by using a compound interest calculator.

To Beat Inflation

Inflation refers to the overall increase in price level of products over time. If prices are rising over time, this means your money buys less today than it did yesterday. If there is inflation over a period of 30 or 40 years, your money will be worth considerably less while the cost of living has grown. One way to beat inflation is to invest your money. If your money earns more than the inflation rate, this means your money is worth more tomorrow than it is today.

Retirement

If you plan on stopping work and retiring, you need to have a large amount of money saved to live off of when you no longer work. Investing can help bridge the gap between what you save and what you need to live off of for 20 or 30 years.

To start investing for retirement, you can start working backward from a number you set for yourself for retirement savings. That number can be determined by thinking about how soon you want to retire, and what kind of lifestyle and expenses you think you will have in retirement. You then can come up with an investing strategy for retirement aligning your current financial situation with your retirement goals.

How Much Money Should You Invest?

While you can invest for short-term goals such as buying a home, most people invest to fund their retirement. In the U.S., people typically choose to retire around 65 years old if they are financially able to. This means that for the reminder of their lifetime, they will need to rely on their investments to fund their lifestyle. There are still expenses that need to be paid in retirement, such as utilities, housing, food, and any travel.

To figure out how much you should invest now to fund retirement or other goals, financial experts suggest a few different methods.

These rules or formulas may not work for everyone. Consider your financial situation before deciding how much and how to invest your money.

Save 20% of Your Paycheck

Some experts suggest saving 20% of your paycheck. That means you can live off 80% of your income for all of your housing, needs, and wants. This method is used by many for the simplicity in setting aside a portion of their money each paycheck. In most cases, you can automate 20% of your paycheck to go directly into an investment account each month, which makes this method one of the most favorable methods to use. However, that may not be possible for everyone.

The 4% Rule

Another rule of thumb that many financial experts use is the 4% rule. It suggests that by withdrawing 4% of your retirement funds each year, you will have enough money to live off of, while still generating enough returns to maintain its current value even after adjusting for inflation. For example, if you have $1.25 million in retirement savings, in accordance with the 4% rule, you could withdraw $50,000 in the first year. The next year, you should be able to withdraw another 4% of the remaining balance, and the cycle should continue for each year you live in retirement.

This rule is useful because if you can estimate your annual expenses in retirement, you can work backward from this amount, and determine how much money you need to save each month during the time you have left until retirement.

One Investment Strategy Does Not Fit All

Your investment strategy is personal and should depend on your goals and risk tolerance. You may have a few short-term goals, such as purchasing a car or home, and also some longer-term goals, such as saving for retirement. Understanding your personal risk tolerance is important because different people are willing to stomach large swings in the value of their investments, while others get very nervous if an investment falls in value.

Often, investments recover in the long run. The S&P 500, which is one of the major stock indexes people track, has given an annualized 12% return over the last 10 years as of March 2022.

If you are uncomfortable with risk, this will shape your investment strategy toward more diversified or even short-term assets. Longer-term investments could be riskier in some assets because there is more uncertainty over a longer time horizon; however, for some assets, a longer investment period may help average out periods of outsized short-term gains or losses.

With investing, there is a risk-reward trade-off, which means when an asset has more risk, it tends to pay a bigger reward.

Figuring out your personal investing strategy may take some time, and most investors adapt their strategies because their life circumstances are different and may change over time. For example, people who are younger tend to be riskier in their investments, whereas older adults tend to be less risky since they have fewer working years to recoup any investment losses.

Bridging the Wealth Gap

Investing can also help people and communities who often find the deck stacked against them due to the wealth gap when it comes to financial opportunities.

Women, for example, typically would need to invest more and for a longer period of time to meet retirement goals, because they are often paid lower than their male counterparts for the same job, and because the average worldwide lifespan of a woman is seven years longer. Even though research suggests that women are better investors than men, they tend to be more conservative in their investments, so taking a more proactive and aggressive strategy could benefit women.

Individuals within Black or Hispanic communities are known to have less resources and wealth, which is exacerbated by the worsening of the racial wealth gap. According to the 2019 Survey of Consumer Finances, Black households had 7.8 times less median household wealth, and Hispanic households had 5.2 times less median household wealth than White households. Investing may be a small step toward helping to narrow down this wealth gap.

How To Start Investing

You don’t need thousands of dollars to begin investing. You can set aside a little money each month to begin your investing journey. Let’s think about a simple example in which you set aside $100 each month from the age of 25 to 65. If you just put this money into your checking account, you would end up with $48,000 in 40 years ($100 x 12 months x 40 years = $48,000). However, if you invest the money and earn a 10% annual interest rate, compounded annually, your $48,000 will grow to more than $530,000. Your money makes money over time.

You can begin investing by talking to your employer to see if they have a retirement account such as a 401(k) or 403(b). You can contribute a portion of your paycheck each pay period toward your retirement account and begin selecting investments that are offered to you. If you are not offered a retirement account at your employer, you can also invest in an individual retirement account (IRA).

You can open one at a brokerage firm or an online brokerage firm such as TDAmeritrade, Wealthfront, or Charles Schwab. At a brokerage firm, you can also open a private investment account to begin investing. These types of accounts do not have penalties if you pull out your money before you hit a certain age, like a retirement account does, but they also do not have some of the tax benefits that come with a retirement account.

Frequently Asked Questions (FAQs)

Why is diversification important in investing?

Diversification allows you to spread your money across many investments, which minimizes risk. If one company or asset class does not perform well, diversification will ensure you do not lose all of your money, because you have multiple investments.

Why is investing important at a young age?

Investing early allows you to take advantage of compound interest. Investing at an earlier age also allows you to begin creating wealth sooner. If you wait to begin investing, you may need to put away a lot more of your paycheck to meet your personal and financial goals.

Why is ESG investing important?

ESG investing is also commonly called “socially responsible investing” or “impact investing.” ESG investing is important because matching your investment choices with your personal feelings and goals allows your money to work toward companies you feel are important for society.

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