I’m writing this post to my younger self, this is a post for every 16, 20, or 30 something year old who knows that should be worrying about saving money for retirement but believes the following:
- I have plenty of time before retirement, I don’t have to start saving now for it.
- Nobody can save $1,000,000 in 30 years! Heck, that’s $2,777 saved each month.
- I can only invest if I have $10,000 or more saved.
I wish I had someone reading this post to me when I was younger because oh boy… I was so wrong! A long time ago I was reading an article about investing and the following statement got stuck with me forever:
When is the best time to invest? The best time to start investing is when you were born, the second-best time would be yesterday and the third best time would be now!
I thought it was a joke, but it makes so much sense to me today. Time is your best friend when you invest, time is the most important resource (and not money) when you invest in anything and especially when you invest in the stock market.
Compound Interest, or the “snowball effect”
Compound Interest is going to be your secret weapon when you start investing in the stock market, but to make this secret (not so secret now) weapon work, you need to ingredients: Time and Invested Money.
What is this all about? Let’s use an example to explain compounding:
Let’s start with an initial investment of $1,000, we will add $100 to our account for 10 years and will re-invest the interest earned on our investments.
Assuming a very low return of 3%, on year 1, you would have contributed a total of $2,200 and earned $31.25. By year 2 to you will have contributed $3,400 and earned $81.71 in interest, did that catch your attention? Is more than double what you earned on year 1, why? Because you are re-investing the interest earned, and that interest also earns interest! By year 10 you would have added a total of $13,000 and earned $1,493 in interest.
I know, that doesn’t seem like a lot and that’s because the rate of return was set at 3%, but did you know that the performance (return) of the US Stock Market on 2017 was of 19%!
Let’s now do the same example but we will increase the return from 3% to 9.8% (source) which is the “average” return of the stock market. By year 1 you would have earned $157 in interest, by year 2 it would be $455 (3 times year 1) and by the end of year 10, a grand total of $9,905!
Mind blown, eh? And that is only 10 years, what happen if you do that for 30 years using real stock market returns (including stock market crashes), you can have more than $500,000 in your account, and I can show you that on the “How to Turn $100 into $500,000” blog post.
Time is your friend
Now that you know about Compound Interest and how it works, then you have realized that in order to make it work, you need to have your money for a long time gaining that sweet interest, but more importantly, because of this snowball effect, the sooner you start, the fastest you will reach your investment/retirement goal, but not only that, you will need less money from your pockets to make it happen.
Let’s make another example. Let’s assume that we have 3 friends, Jennifer, Anna and Chloe. Jennifer is 19 years old, Anna 32 years old and Chloe 25 years old. They all went to my blog and got excited about investing in the stock market, they all decided to start investing. After a couple weeks, Jennifer and Anna opened their accounts and started investing but Chloe still got scared about investing in the stock market and he instead decided to put all her money on a savings account.
Let’s assume that the stock market had a yearly average return of 9.8% and that Chloe’s savings account had a yield of 2% (I’m being nice, the average is 0.06% in the US and 1% in Canada). So, how did it go for them when they reached 65 years old?
She started investing in the stock market and added $1,000 yearly to his account, but by the time she reached 30, she gave up investing, she still left her money gaining interest, but she stopped contributing to her account. When she reached 65 she opens his account and finds that she has $700,634.66 on it! How much did she put from her pocket? Only $13,000, that’s a $1000 from age 18 to age 30.
Anna knew that she didn’t have much time as Jennifer and Chloe to allow her money to grow with compound interest. That’s why she from age 32 to age 65 added $1,000 to her account no matter what. When she reached age 65 she found she had only $257,860.06. Not bad, is not $700k, but is WAY better than $0. Keep in mind that she contributed $34,000 from his pocket.
Chloe kept thinking that Jennifer and Anna were gamblers, that investing in the stock market would be risky and instead, the best way to “invest” her money would be to put it on a savings account. She religiously saved money year to year, and like Jennifer and Anna, she added $1,000 each year to her account from age 25 to age 65, that’s a total of $41,000 from her pocket. When she opened his account at age 65 she got really disappointed. Why? Well, she only had $63,862 on her account. She “invested” for 40 years and barely got $20,000 extra for her retirement. Sadness…
If you are on your 20’s, please, by all means, start investing now! And if you are on your 30’s or 40’s, don’t get discouraged, is never too late to start investing. I personally started investing late and I know how it feels, but you know what is worst? Having $0 on your bank account when you are close to your retirement age.
And what about Chloe? Well… just don’t be like Chloe… I get it, trust me I do, we all work really hard to make money and the last thing we want to do is to recklessly lose it, this is the reason why most of us don’t invest and stick to a savings account.
It’s important to have money in a savings account as an emergency fund, but don’t trust your life savings just to your lousy savings account, instead, invest that money in the stock market, and if you can, also have other types of investments like real state. Diversification is the key!
How do you invest in the Stock Market?
Now I caught your attention, eh? Great! This blog is dedicated to help you learn how to invest in the stock market. I have many great posts, but since you are just starting in the world of Investing, I recommend you to start reading these posts.
In “How to achieve financial freedom through the Stock Market” I will teach you a very simple but wonderful strategy to start investing in the stock market even when you are still figuring it out. Why this strategy? Well, great investors like Warren Buffett, Charlie Munger and John Bogle who have over a century of combined investing experience and knowledge, all recommend that you should start with Index Investing, which is, buying one fund that contains the entire US Stock Market.
Also, in “How to become a badass investor in 5 steps” I Will teach you how an investor thinks and acts regarding stocks, investments and retirement. Finally, in “How to find great stocks even when you don’t know where to start” I will share with you the “secret” strategy that I use to find great stocks for my portfolio.
If you are feeling a bit overwhelmed by all this (I know I was when I started) I encourage you to get my Free “How to Invest in the Stock Market” e-mail course! Also, you should join my private Facebook community where you can reach me and other investors for questions