Ah, now we’re getting to the good stuff; now that you’re not spending all your money, have a decent emergency fund and have debt under control, it’s time to start having your money make money. If you want to retire (who doesn’t?) and aren’t earning several times the amount of money you spend each year (who does?), you need to put some portion of your money aside in investments that will grow your money at a rate faster than inflation, fast enough to let the magic of compound interest take hold and leave you with a sizable retirement fund (or college fund, or whatever you are attempting to save up to achieve). In other words, you need to
Invest Early and Often
Getting your investments started as early as possible is one of the best ways to increase your net worth that exist. Thanks to the power of compound interest, where the interest you earn in turn earns more interest, which in turn earns even more interest, you can turn a relatively small initial investment into a sizable fortune. Each dollar you invest at age 20 will turn into thirty two dollars by age 65 (assuming you earn a fairly modest 8% return on your money). If you wait until age 30, each dollar will grow to only about fifteen dollars by age 65, less than half of what you’d earn by starting a decade earlier. It only gets worse from there: start at age 40 and your dollar becomes seven dollars; start at age 50, and your dollar will only grow to three dollars when it’s retirement time.
Starting your investment career early has some other advantages, as well; you have more options for what investments you can use when you have more time available to recover from your mis-steps. If you want to choose highly speculative investments, the types that could either greatly grow your initial investment amounts to huge sums or leave you completely penniless, it’s much, much, much better to do so when you’re 20 than when you’re 40. While I certainly hope that you have good luck and end up with a sizable amount of money, if you do end up losing your shirt, it’s much easier to pick up the pieces of your financial life at 30 compared to 50 (just look at the difference in the grow of your money starting at those two ages).
Conversely, if you want to invest more conservatively, starting earlier gives your investments more time to grow, allowing you to stick with investments that allow you to sleep at night while still growing your money to meet your goals. If you’re earning only five percent return on your money (perhaps by investing in bonds, or even keeping your money in a savings account when interest rates start to go back up again), it’s important to get an early start to allow time for compound interest to work its magic. Starting at age 20 and earning a 5% return will yield nine dollars when you’re 65; wait until age 40, and you’ll have less than $3.50.
Of course, most people don’t put a lump sum into their investments and then just stop, only taking the money out at retirement. No, most people follow the second part of our advice and invest often, putting aside a bit of money monthly or whenever they get a paycheck. The advantages of investing regularly really add up over time. Remember how each dollar invested at age 20 grew to thirty-two dollars by age 65? If our twenty year old added an extra dollar each year, by sixty five he or she would have a total of $418. If we use more realistic numbers (after all, who invests only a dollar each year?), say $5000 each year, investing each year yields a total of over $2 million, compared to $159,000 for a single five thousand dollar investment at 20.
Investing often also allows you to dollar cost average your investments. By putting in the same amount of money on a regular basis, you’ll buy more shares of your investment when the price is low and fewer when the price is high. If you invest a single lump sum right before a big decline (say, back in 2008), you can end up losing years worth of compounded interest (at eight percent return, it’ll take nine years to get back to even with a fifty percent drop in value). If you invest year after year, though, a sizable drop in value offers you the chance to greatly increase the amount of your holdings, leaving you with a much more valuable investment.
Where to Invest
You’ll notice we haven’t discussed where to invest your money yet. There’s a reason for that: there’s a lot of investment options. From stocks and bonds to options, futures, and forex, a complete list would fill a pretty sizable blog entry by itself. As a result there’s no real way for me to give you a simple rule on what to invest in. You’ll have more options if you start investing earlier (as there’s more time to catch up if you run into trouble and more time to grow your money), but what exactly to invest in is up to you.
If you want a simple, set it and forget it type of investment that will automatically adjust your holdings to something appropriate for your investment goals, you could do much worse than a target date fund. Target date funds hold a mix of other mutual funds that is designed to slowly decrease in risk as you approach the target date (which is generally retirement or the start of college, or another major life event for which you’re setting money aside), making it less likely you’re lose all your money right when you need it. If you choose an appropriate fund from a quality company, a good target date fund (or one for each goal) could be all you need, investment wise, though they’re still far from the only option. Otherwise, reading and learning more about the other types of investments available is your best option. Good luck with your investments!