Through Michael Fischer's video series, we've come to understand that the sooner we invest our money, the longer it has to compound, and to grow to large sums. But things aren't that simple. Compounding has some enemies. One of these enemies is taxes:
Taxes and compounding (4:36)
Because taxes take such a large bite out of our investments, it is especially important to find methods to save that mitigate their impact. Individual Retirement Accounts, for example, allow you to put your money away pre-tax (in the case of a traditional IRA) or to withdraw your earnings tax-free (in the case of a Roth IRA).
Taxes aren't our only concern, though. Transaction fees can chip away at our savings, too:
Transaction costs (1:42)
Every time you buy or sell a stock, you pay a fee. If you invest in mutual funds, you lose a certain percentage every year to administrative costs. These fees may seem trivial in the short-term, but they act as a constant drag, slowing your long-term investment growth. (This is the reason that so many people like index funds: they minimize transaction costs.)
Inflation is a third enemy. This factor is beyond the control of the individual investor. We can seek tax-advantaged investments, and we can avoid transaction costs, but inflation is part of the broader economic picture. When prices rise 3-4% each year, our investments are worth that much less. (The guaranteed loss to inflation is a powerful argument to minimize those costs we can control, such as taxes and transaction fees.)