I've Saved...Now What?

If you are reading this, you probably have some money in a savings account that you are thinking of investing. You probably have also realized that a savings account is hardly working for you given the paltry interest rate it earns.

Investing is different from saving because it involves the risk that the value of your investment could rise and fall. Plus there is no guarantee of principal or return. Still, it’s difficult to get to your long-term goals without investing. Investing in the stock and bond markets has historically provided greater returns than most investors can earn through just savings. In fact, the risks of investing diminish over time, while the hidden risk of saving increases over time. That risk being that you won’t be able to keep up with rising prices or inflation.

So where do you put it? If you're young, most of your investing dollars should really be in the stock market. If you have a long life ahead of you, or a long “time horizon”, you can weather any dips in the market and reap the rewards of long-term gains. As you get older, you should incrementaly transition from stocks into bonds as you depend more on your investments for income.

Will this cut into your spending now? Yes, but the cost of not investing may be worse for your retirement. For example, say you spend $5,000 of your income each year on stuff you don’t need. Sounds like a lot? A latte a day or brown-bagging your lunch and you are half way there. Say that money returned an average of 9% after-tax a year. After 30 years, how much do you think that $5,000 a year would be worth? $681,000 dollars.

So why does investing work long-term? It is the power of compounding that potentially makes investing long-term profitable. When your investments begin to earn money, those extra returns start to earn money, and so-on and so-on, your investments can build up quickly. Extend the time period or raise the amount you are investing, and your results increase dramatically.

The power of compounding is the single most important reason for you to start investing early.

One word of warning though: there is no guarantee that the market will go up the first day, the first month, or even the first year that you invest in it. But one thing is fairly certain, doing nothing will unlikely provide for a comfortable retirement. There is no reward without risk. Stocks have expected higher returns because they also carry more risk (or the possibility that your investments drop in value in any given period).

In fact, the trade off between risk and return is one of the most fundamental things to understand about investing. Even a well-diversified portfolio is still subject to market risk – the risk that the stock market drops. That is why investing is a long-term activity, in order to accommodate these fluctuations. Still, as the potential for loss increases in stocks, so do the potential gains. You get “paid” for taking on risk in the form of greater returns. Do you want to get paid?