Regardless of economic background or walk of life, most individuals make money in two ways: earning it through work and investing. Though for the first-time investor, this second option can feel daunting and inaccessible.
Overall, it’s simple enough: Investing primarily involves the purchase of a financial asset or security, and realizing a profit over time from its returns, usually in the form of dividends. Investors might also purchase a security when its price is relatively low, wait for it to increase in value, then sell it when it’s high.
But between the plethora of investment vehicles available — from stocks to mutual funds to exchange traded funds (ETFs) to bonds and all the others in between — it can be tempting to simply throw in the towel and focus on earning and saving only. And this approach might make sense on paper, given that savings accounts do provide interest on the amount saved.
But choosing to only save money instead of investing makes it more difficult for one to increase earnings and attain greater financial stability.
Despite the seemingly wide learning curve, anyone who is able to save can also invest — and investing is key to attaining financial goals in both the short and long term.
Here’s a beginner’s primer on the benefits of investing, and what investors should know as they start to grow their investments:
Why Is Investing Important?
More often than not, the importance of investing becomes sorely apparent after the fact, when the would-be investor recognizes the growth their cash would’ve attained had they acted sooner.
This was true for Emily Lankley, a former publishing professional based in New York City, who after leaving her job was tasked with rolling over her company-sponsored 401(k) into an individual retirement account (IRA).
While she could previously leave her default options in place, the task of picking and choosing investments now fell to Lankley, who quickly felt paralyzed by the breadth of options available. And in the process of not making a choice, her funds slowly gathered cobwebs, denying her the previous growth she’d become accustomed to.
While this is just one example, it demonstrates how a lack of investment planning deprives individuals of future earnings.
Investing serves as a tool for individuals to achieve goals, regardless of whether those goals are within the next few years or in the next few decades.
Whether it’s retiring in confidence, buying a house, paying for a college education, overcoming debt, or simply improving one’s quality of life, the value attained through any number of investment vehicles can help in making those dreams a reality.
Moreover, investing serves an important role when many of these goals become more expensive with each passing year.
Everyday expenses increase in cost as time goes on. Beyond the cost of living, home prices shot up by 5.4 percent in 2020, per the Federal Finance Housing Agency.
These rising prices are unfortunately likely to continue. But regardless of the financial goal, the returns on well-tailored investments can surpass increasing costs and make future expenses affordable.
How to Start Investing
As stated previously, anyone who has money to save has money to invest — and contrary to popular belief, investing is not just for the affluent.
The first step for a beginner investor is to budget for investments alongside monthly expenses and contributions to an emergency fund.
This process might involve seeing where expenses can be cut in order to free up more funds for both savings and investments. Once a budget is formed, the investor has a solid idea of how much of each paycheck can be put into an investment.
It’s important to note that the amount invested should come after emergency savings are set. Investing shouldn’t replace putting away money for a rainy day, as this approach can lead to a serious financial bind should the investor lose their job or suffer another dramatic setback.
“You want to consider your current financial situation,” advises Charles Lara, an investment specialist and certified financial planner at Victory Capital. “The reason I say that is because it is important to make sure people live on a budget they are following so they can afford to save and invest. Part of that is having emergency savings.”
It is during this introductory period that investors should consider their short- and long-term specific financial objectives (like home ownership or financial freedom) — and what they will do to realize them.
If a would-be investor feels that the money they’ve put away each month will be insufficient to realize those goals, they might want to consider revisiting their budget, and seeing what expenses can be cut further to free up more funds.
When it comes to making difficult choices in terms of reining in spending, Lara recommends going back to basics.
“It really goes back to the purpose or why they started to invest to begin with,” Lara adds. Keeping investment goals in mind can help when refining a budget to better meet this goal.
Why Investing Is Important Right Now
Investing today is important given the role time plays in asset appreciation, especially when annual returns on many investments tend to dwarf the rates offered on savings accounts.
For example, let’s say an investor has assets that historically net a 5 percent return, give or take. Compared with the average Annual Percentage Yield (APY) of nearly 0.08 percent for a high-yield money market account, per the Federal Deposit Insurance Corporation, the numbers speak for themselves.
Let’s say an individual has the choice of investing $100 per month, or putting $100 in a high-yield savings account.
In five years, that investor would have over $6,700 from their monthly contribution assuming a 5 percent return, as opposed to roughly $6,000 from a savings account from a 0.08 percent APY. And within 10 years, the investor would have over $15,400, compared to the saver’s $12,043.29.
While the difference in wealth between the savers and the investor is only $700 over half a decade, the second example demonstrates how higher returns with more investment time net greater investment earnings.
Beyond the return on investments, investing earlier helps to beat the diminishing value of currency each year.
Money loses value with each passing year as a consequence of a process called inflation. But careful investing can allow an individual to grow their money faster than the rate at which it loses value, possibly preventing this loss of value.
While the value of a single piece of currency may continually decrease, an investor whose earnings have grown has earned more money, as a consequence of their portfolio’s growth, offsetting this decrease.
Understanding Risk Tolerance
Of course, an investor will beat the inflation rate, or the rate on a savings account, only if their holdings appreciate in value more than inflation. But in investing, asset appreciation isn’t guaranteed — there’s a degree of financial risk involved.
Investors face financial risk given that the possibility exists that they may lose money on their investments. Their holdings may depreciate in value, financial markets might suffer a recession — any number of factors could cause a range of financial damage
All investors face risk of some degree — but investors differ in terms of the risk tolerance they may have individually.
“Risk tolerance basically means a tolerance for a level of volatility that one is willing to accept in exchange for the potential of performance or return,” says Lara.
Even investors who purchase financial securities that are understood to be “safe” need to remember that there is a possibility of greater loss, should their plan not work out — and that nothing’s a sure bet in financial markets.
“Past performance of an investment is not indicative of future performance — this is something that we mention to clients when discussing performance,” explains Lara. “While you may want to expect a higher return, it’s all hypothetical.”
The Importance of Diversification in Investing
Part of what determines an investor’s risk tolerance comes from their financial goals, and whether they’re willing to accept more risk to achieve them. But another part of this decision-making comes from the investor’s circumstances or time horizon.
For instance, an investor in their 20s may be more willing to take on risk as opposed to an investor in their 40s, who may have more tangible financial goals they feel they are closer to realizing. And an investor in their 60s who is nearing retirement may want to reduce as much risk as possible as to not jeopardize their nest egg.
One of the ways in which individuals mitigate risk — or ignore it — boils down to how they diversify their holdings.
Diversification refers to the process of purchasing different types of financial assets.
By making different types of investments, the investor reduces their exposure to financial risk in the event that one of their assets loses value suddenly. Overall, a well-diversified portfolio provides more predictable growth because financial risk is spread out over different asset types. This makes financial goals more attainable as there are less fluctuations overall.
The ways in which individuals diversify their portfolios will largely depend on their time horizon, according to the Securities and Exchange Commission (SEC).
Investors should consider how long they are able to invest, their financial goals, and their tolerance for risk when diversifying their portfolio. And with the passage of time and the changing of life circumstances, investors should also be willing to alter their portfolio’s makeup to reflect the risk they are willing to take.
Moreover, an investor who is looking to mitigate risk while still maximizing their earnings should consider enlisting the help of a professional, such as a certified financial planner, who can help them meet their financial goals.
It may also help to enlist the services of an investment professional who understands the circumstances and aspirations of their client, as some financial planners may be more acquainted with individuals of a specific age demographic.
What Else to Consider When Investing
Beyond considering the risks inherent to investing, beginner investors should consistently remind themselves that, like everything else in life, investments are far from a sure thing.
Life can throw a number of curveballs — individuals can lose stable jobs or incur large bills when they least expect it; the same kind of volatility applies to a financial portfolio.
These risks, however, shouldn’t deter individuals from investing as a means to meet future financial goals.
Even the most diverse portfolio can suffer and lose value in a bear market — or worse, a recession. But historically, financial markets have had more upswings than downswings, according to the Federal Reserve Bank.
This means that even though a possibility exists that investments may lose their value, markets have a way of readjusting and “returning” the wealth to investors who hold onto their assets throughout the storm — and even increasing in value after that.
So despite the volatility of investing, they are (in the long run) powerful tools for attaining financial goals — provided the investor doesn’t overreact and sell at the first sign of trouble.
“When investors are anxious or nervous, I take a step back and ask ‘Why did we start this investment to begin with? What are our investment goals?’” recalls Lara. He adds that many people confirm their goals are long term, which means there’s not much to do right now, nor reason to panic.
Beyond the dangers of the market, it’s important that investors relying upon the advice of a professional choose an individual who is going to help them achieve their financial benchmarks.
To that end, individuals should check a financial planner’s or fiduciary’s status using the SEC’s background check tool.
The Bottom Line
Understanding the importance of investing is half the battle, as is comprehending all of the requirements inherent to careful financial planning.
Although this value wasn’t understood by Emily Lankley initially, she, like many other successful investors, found help from a financial advisor well attuned to her situation. And though Lankley’s IRA still suffers the whims of the market (as all investments do), she at least knows that she is slowly, surely building toward the goals that matter.
Investing has helped millions of individuals attain financial success they wouldn’t otherwise see by just saving and working. And while it may seem inaccessible at first, would-be investors can start with as a little as $100 — though beginners should take strident steps to ensure their investments gain value in the long run.
Tailoring a portfolio to fit one’s risk tolerance and ensuring the portfolio is diversified to that end are key steps in that process — as is getting help from a qualified professional to ensure your investments are tailored for future success.
