Why should I invest?

Why invest? With so many risks--and savings accounts insured by the FDIC--why should you invest when you could simply save?

You'll find as many answers as there are personal finance experts, but nearly everyone can agree that if wealth is your desire, investing is the best way to acquire it. Relying on interest from your savings account alone may help build financial security, but it is no comparison--in either risk or reward--to making an investment.

Can you get rich through saving alone?

You could become rich through savings alone, but you'll have to work a lot harder; and, perhaps, never stop working. If you want to get rich slowly, as we say here, investments are the way to go, especially income-producing investments like bonds, stocks that offer dividends, and rental real estate.

Savings accounts are indeed safe, but often the interest rate, the "return" on your money, is barely the rate of inflation--sometimes, it can even be less. So you'll put your money into the bank, and when you're ready to retire, that sum won't have grown much.

The magic of compounding

Unless your job pays extremely well or you are extraordinarily frugal, it's a struggle to become wealthy with simple interest. Investing will (if it's done right) introduce you to the magic of compounding. Here's how it works: If you invest $100 today, and earn an assumed return of 8% a year (investing in an S&P index fund would have, over time, returned about 9% a year), your investment would fall in some years and grow in others, but your money would theoretically grow as follows:

  • In 10 years, it would be $215.89
  • In 20 years, it would be $466.10
  • In 45 years, it would be $3,192.04

If you add money annually or (better yet) monthly, or if you increase the amount you add over time, your money will be more likely to grow. Savings will, for the most part, simply keep your money safe. But it won't do much work for you.

The investment ladder

There are relatively safe investments, like certificates of deposit, or CDs, a hybrid between investing and saving. CDs may be a good place to begin if you are still unsure about taking too many financial risks.

Index funds, as mentioned, are another fairly safe investment (the risk is spread throughout the hundreds of stocks, in a huge variety of industries, on the index in question) and typically return more than CDs.

Investing in individual stocks can provide a much higher return, or it can be a disaster; even well-educated and even better-paid mutual fund managers rarely outperform the index funds.

Investing in real estate, the sort of plan espoused by some financial authors, can be great or disastrous. Investing in small businesses is one of the riskiest investments of all--but also, one of the most common ways individuals seek to grow wealth.

Choose your investment based on the risk you're willing to take, but whatever it is, investing responsibly is the most reliable way to get rich, slowly.

This Guide to Money answer includes the topics: Invest.

 
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