Chances are, if you are in college, or just graduated and are working your first job, investing is the last thing on your mind. You have exams to study for and papers to write, or worse, rent to pay and student loans to worry about. So why should you bother investing, especially if the amounts we’re talking about are so minimal? If you only can save $25 dollars a month, is it even worth it? Well, funny you should ask! There are tons of reasons why starting sooner is better than later, but my goal is not to make you feel guilt. Your other friends can do that for you. However, here are four simple reasons why I think it’s important to start now:
- You will start a habit of saving (in order to have money to invest).
- You can learn skills that will serve you down the road.
- “The most powerful force in the world is compound interest.” -Albert Einstein
- You can explain to your friends what a 401(k) is.
Okay, so maybe not everyone cares about the last one. But kidding aside, the other three reasons are extremely important for you to understand why investing is something to start as soon as possible. Even if the amount of money you have to play around with has less than three zeroes behind it, you can learn some fundamentals. I’ll be covering these here at Investing Part Time over the course of the next several weeks, so be sure to subscribe via RSS or email!
1. Start a habit of saving
Saving is a great skill to start, even if you are mired in student loans and credit card debt. Obviously, we want to pay down our loans and debt as soon as possible to avoid interest payments, but if we have no idea where our money is going each month, then it’s harder to budget for payments. By developing a savings program, even if its only $25 a month, we train ourselves to be more financially responsible in the long run. Ramit Sethi over at I Will Teach You to be Rich (a great personal finance blog to follow too) has an awesome post on savings and how to automate this, so instead of reiterating it, go check it out first. If we can effectively budget to save, then there’s no reason why we can’t budget to invest. Again, even if it’s a small amount each month, it will add up over time.
For saving, I use ING Direct and for checking I use Charles Schwab. Both are free accounts with no minimums are any hidden fees. Schwab is especially great because they refund ATM fees that you get charged anywhere, so in effect, you can withdraw for free from any ATM, period. ING is good for our purposes because they pay a modestly higher interest rate than other banks (although don’t worry too much about this as the amounts in question are trivial) and you can set up automatic deposits each month (what we’re more interested in). Schwab also pays a nominal interest rate, so you at least earn a small amount of money each day that you have money in there. The one catch for Schwab is that they also sign you up for a brokerage account and encourage you to fund that (basically, how they make money to begin with), but you don’t need to put any money in that. I don’t use Schwab for their brokerage because they charge higher commissions than you need to pay. I’ll cover how to pick a brokerage in an upcoming post.
2. Learn skills that will serve you well down the road
The second point is that investing teaches you skills that will serve you well down the road. I’m not talking so much about knowing how to value a company (although I do think that’s pretty cool) as I am about knowing how to take calculated risks and understand intricacies of both businesses and investor psychology. Risk is one of the hardest concepts for new investors to fathom, and it is misunderstood mostly because financial advisors and mutual fund companies perpetuate the idea that there is such thing as a safe investment. The reality is that there are no safe investments, period. Some investments offer better safety than others, but that doesn’t mean your money can never decrease or disappear. Treasury bonds from the U.S. Government are considered the gold standard when it comes to safe investments, but that all depends on the ability of the country to issue new debt and retire (or pay back) old debt. I’m no economist, but I have trouble believing that the country can continue on in the same fashion and not encounter problems down the road.
Even so, putting your money away in a mutual fund and not looking at it for the next 50 years is not sound investment advice. If you follow the markets and revisit your investments a little more frequently, and still conclude that the mutual fund is the best place to keep your money, then that is different.
Understanding the intricacies of businesses is helpful because it has real world implications. If you read the annual reports of two popular companies in the same niche (say GM and Toyota), but find that one of them offers a better company warranty, then you might be more inclined to buy from them when you’re on the market for a new car.
Similarly, understanding investor psychology is equally important, as it has its roots in the most basic of human emotions: fear and greed. Prices sometimes rise simply because people are greedy and want to get in on the action; prices sometimes fall simply because people hear rumors or get scared when they see their own money disappearing down the drain. Understanding why the prices of stocks move is an extremely valuable skill to have. Check out this post I wrote about why the stock market changes every day to learn more.
3. The most powerful force in the world is compound interest
The third point is one of my favorite all time quotes, where Albert Einstein talks about compound interest being the most powerful force in the universe. Irony aside, compound interest is pretty darn cool. To see it in action, check out the chart below. I assumed a starting value of $1,000 and an annual interest rate of 15%. No money is being added each year except the interest accrued.
After 10 years, this $1,000 more than quadruples! The money that you earn in interest (or in stock gains) one year, if left in, becomes the base amount the following year. Then that base amount is allowed to compound. This process repeats as long as you have money in the market or in a bank account. No wonder the value keeps increasing!
What point am I trying to make? Even if you just put a little bit of money into the markets or into savings, you will let this money grow each year as long as you don’t withdraw. Although the average stock market returns are supposedly only around 7-8% a year historically, that still means that your money will double 9-10 years. The magic of compound interest is truly amazing.
Final thoughts – Take one actionable step
If you only take one small step right now, set up a savings account with ING and link it to your checking account. Then set up an automatic deposit each month. Start small, with $25 or $50. If you aren’t certain that you can do that each month, then make a one-time deposit for now, and you can continue to add in more later. Once you give it some time, the money will grow slowly and you’ll have some capital to invest with. (Capital sounds way cooler than plain old money, right?) Even if you don’t think about investing for the next six months, you’ll be automatically putting money away each month that you can use later. As you’ll find out, automating and creating systems are some of my favorite things–they are especially useful when it comes to personal finances and investing.