Financial Awareness Month: Why Doesn’t My Dollar Make Cents?
What is investing, how to start, and other important considerations.
What is Investing?
Investing is putting money in financial products like stocks, bonds, mutual funds, ETFs, and real estate with the expectation of growth and income.
Some Important Distinctions
As you begin your financial journey, understanding some fundamental distinctions will help build your knowledge about investing.
Savings vs. Investing
Savings—storing part of your income in a bank account as your emergency fund for near-term purchases with easy access and no market risk. The purpose of having a savings account is not to generate long term growth, but to have safety and liquidity.
Investing— a more active way to diversify your wealth, giving you the opportunity for potential future growth. Typically, this is a long-term strategy and is susceptible to the market fluctuation.
Speculation vs. Investing
Speculation— when you seek high returns that take on high risk within a short period of time.
Investments— are generally longer-term and can have varying degrees of risk. The amount of risk a person takes on can be determined by his or her age, income, when you need the money, and your comfort with market fluctuation.
Knowing your personal risk number is the first step to understanding investing! Click the button below to answer a 1-minute quiz to learn about your risk score:
5 Reasons Why Investing is so Important
Help you reach your financial goals
It is important to first establish a plan for your goals: what are they, how much do you need, and when do you need it? Once you establish your goals and how much you can save towards those goals, you are able to choose investments that are in line with your objective and risk tolerance.
Investing can be tax efficient
There are a few different ways investing can be tax efficient. One that comes immediately to mind is contributing to your 401(k) or qualified IRA on a pre-tax basis. Contributing to your qualified retirement plan on a pre-tax basis actually decreases your taxable income in the eyes of the IRS. Of course, this may not apply to everyone, so it is important to meet with your tax adviser to figure out the most meaningful way you can reduce your taxes.
Tip: Many employers match a portion of your contributions in your 401(k) or other qualified plan. Simply by making an investment, coupled with the company match, you are already doubling the amount you are saving for retirement!
It can help you beat inflation
Simply put, inflation is cost of goods and services increasing over time. This is important because a dollar today will not be worth a dollar tomorrow, most likely it will be worth less! Investing in a diversified portfolio may help an investor hedge or even exceed the increase in costs of goods and services.
Compounding interest & dividends
This accounts for your initial principal and accrued interest from previous periods over time. Also, some bonds pay interest and stocks/funds pay dividends —these are typically quarterly payments from companies to share holds from their profits. A simple metric of the effects of compounding interest is using the Rule of 72s—the approximate time over which an investment will double, given a specified rate of return. To determine this figure, you will divide the interest rate by 72. For example, if you have an interest rate of 10%, it would generally take 7.2 years to double your money (72/10%= 7.2 years).
The importance of staying invested
Historically, staying invested for longer periods of time tends to offer higher potential returns. When you pull your money from your investments when the stock market drops, you miss out on the potential growth during the recovery. Understanding this is easier said than done, take a look at the S&P 500 Index at inflection points graph below. If you were invested in the S&P 500, and took your money out when the market dropped on March 23rd 2020, you would have missed out on the +96% growth it saw up to July 31st 2021. This is why creating a portfolio in line with your risk tolerance is so important.
Source: JP Morgan, Guide to the Markets
Conclusion
Understanding that there are a lot of resources out there, personal financial advice is more important than ever to help provide you with factual information and tools customized to your needs. Johndrow Wealth Management strives to educate and inform clients to invest in-line with their risk tolerance so they may achieve their financial goals. If you are interested in learning more, we provide a complimentary initial consultation to see if working together is the right fit for you!
Written by Renee Bilodeau
Renee brings a calm and collected approach when working with our clients. Renee helps our financial advisors with investment research, financial planning, and providing caring service to our clients. Renee also is an insurance maven, here to help you with your life, disability, and long-term care questions.
