The Purpose of Investing: A Beginner’s Guide
Are you new to the idea of investing? You might be wondering, "Why should I even start?" Maybe you're trying to move from living paycheck to paycheck to finally saving some money. Or perhaps you already have some savings but it's just sitting in a checking or savings account. So, why invest that money instead of keeping it safe and sound in the bank? By the end of this article, you'll have a clear idea of why investing is a smart move.
What is Investing?
Investing in its most basic essence is putting your money somewhere where it works for you.
It means putting your money to work so it can grow. Think of it like planting a seed and watching it grow into a tree that bears fruit year after year. When you invest, your money can earn more money, even while you're asleep!
Imagine you have two sources of income: one from your job and one from your investments. This second source of income means your money is making more money for you, multiplying your wealth faster. That’s the magic of investing.
So what does “investing” actually mean?
Cambridge Dictionary defines investing as the following:
investing (verb)
/ɪnˈvest/ US
to put money, effort, time, etc. into something to make a profit or get an advantage
Now in this article, we will specifically focus on investing as it relates to money. You can put your money in a variety of investments that will then work to earn money on your money. Some of the common investment types that can help make a profit (or more money) on your invested money are stocks, bonds, real estate, ETFs, mutual funds, annuities, treasury bills, cryptocurrencies.. and the list goes on.
Why Should You Invest?
Take for example the following.
The big question is, why invest instead of keeping your money in a checking or savings account? The answer lies in the potential for your money to grow much more through investing. Here's a simple example to illustrate this:
Let’s say you save $5,000 and decide to invest it. You also add $100 to this investment every month. If your investment grows at an average rate of 8% per year, after 30 years, you would have $186,253. If you increase your monthly contribution to $1,000, you could end up with $1,409,712 in the same period. You would be a millionaire!
That is the power of investing.
Here's a chart showing the growth of your investment over 30 years. The blue line represents a scenario where you start with $5,000 and add $100 monthly, leading to a final amount of $186,253. The green line shows a scenario with a $1,000 monthly contribution, resulting in $1,409,712. This illustrates the significant impact of consistent contributions and compound interest over time.
The Power of Compound Interest
To understand how your money can grow so much, let's look at the concept of compound interest.
Think of rolling a small snowball down a snowy hill. As it rolls, it picks up more snow and gets bigger. Each roll adds more snow than the last because the snowball is getting larger. Similarly, with compound interest, you earn interest not just on your initial amount but also on the interest it has already earned.
Here’s a simple breakdown:
Starting Amount: $100
Interest Rate: 10% per year
First Year: You earn 10% of $100, which is $10. Now you have $110.
Second Year: You earn 10% of $110, which is $11. Now you have $121.
Third Year: You earn 10% of $121, which is $12.10. Now you have $133.10.
Every year, your money grows by earning interest on an ever-increasing amount, much like a snowball getting bigger as it rolls down a hill.
Choosing the Right Investments
What is important to understand is that every investments come in many forms, each with different levels of risk and potential returns..
Some common types are stocks, bonds, real estate, mutual funds, and ETFs (Exchange-Traded Funds).
Stocks: Owning shares in a company like Apple or Coca-Cola. If the company does well, your stock value increases. But if the company struggles, the value of your stocks can decrease.
Bonds: Loans you give to companies or the government. They pay you back with interest, usually with lower risk than stocks.
Real Estate: Buying property to rent or sell at a higher price.
ETFs and Mutual Funds: Collections of stocks or bonds. These are good for beginners because they spread out your risk by investing in many companies at once.
The concept of being able to lose money investing is what deters many from starting in the first place. But the villain in this story is not investing as a whole, but your choice in which investments to invest in.
Take Calculated Risks
Do not let this be a deterrent to getting started with investing. Investing will change your life for the better if you take calculated, measurable, and smart risk.
Investing always involves some risk, but not all investments are equally risky. For example, U.S. Treasury bills are very safe but offer lower returns. Stocks can offer higher returns but come with higher risk. The key is to take smart, calculated risks. Diversifying your investments (spreading your money across different types) can help manage risk.
When you take calculated, measurable smart risk, your money can still fluctuate when invested because there is still risk. However, it will be by making money one day, losing some the next, to make even more money the next day- and the process repeats. And eventually the overall trajectory over a long period of time should trend upward, making you more money in the long term that you started out with.
How to Get Started in Investing
Starting to invest can seem overwhelming, but here are some easy steps:
Start with ETFs or Mutual Funds: These are less risky than individual stocks and offer good diversification.
Use Online Platforms: Platforms like E-Trade make it easy to start investing with small amounts of money.
Take the Stress Out of Picking Your Portfolio: If you have $5,000 or more to start with, you can take a quiz here with our team at LPL Financial. This quiz helps us understand your risk tolerance and investment goals. Based on your responses, we'll create a personalized portfolio of ETFs and manage it for you. This way, you don't have to worry about making the right investment choices—we do it all for you.
Set Up Automatic Contributions: Like saving a little every month, set up automatic investments to grow your portfolio over time.
The best time to start investing is now. The earlier you start, the more time your money has to grow through the power of compound interest. Don’t wait for the perfect moment—take advantage of the opportunities available and let your money work for you.
Investing is a powerful tool to build wealth and achieve financial freedom. Start now and watch your money grow over time. Happy investing!