Saving and Investing

Saving and Investing

Saving and investing will allow the money you work so hard for to also work for you over time.  Understanding saving and investing entails not only concepts of compound interest and time value of money but also knowledge about all of the services and investment vehicles that financial institutions offer. For the entirety of your life, you are your own most important creditor. You don't owe money to anyone more important than yourself. Live by this rule of thumb, and you will be on your way to living with a high degree of financial well-being. Paying yourself first, early and often will allow you to take advantage of compound interest and the time value of money. 

 

The importance of compound interest, time value of money, and decision making 

Compound interest

There are two types of interest that you can be paid on your saving and investing accounts. Simple and Compound Interest. Interest, either simple or compound, works both for you and against you depending on the situation. 25% interest on an investment - great idea.  25% interest on an auto loan - bad idea.  Simple interest means that when you receive an interest payment, it is based on only the original amount invested. Compound interest means that when you are paid interest, each payment is based on the original amount plus any interest that has already been paid. As you may have guessed, compound interest is the way to go when saving and investing. Below is an example of compound interest at work. Notice how beneficial starting early and contributing often can be over time. 

 

As you can see, there are huge advantages in your ability to save and invest as early as possible.  Another important consideration is that you don't need to have large sums of money to begin paying yourself and investing for your future. As you will learn in the budgeting module, it is recommended that you commit to saving 10% of your net income. This is true regardless of your income. So if you only make a couple of hundred dollars per month, save 10% of that. If you make a few thousand dollars per month, save 10% of that. If you make a million dollars per month, well, you get the picture.  

 

Time value of money

The reason that compound interest over time is so beneficial to you has to do with the time value of money. This concept simply means that money in your hand today is worth more than that same amount at a later date because you can invest the money you have today at a given interest rate. Doing this allows that money to grow for you over time.  When you combine compound interest and the time value of money, it becomes easy to see how saving and investing early and often can be so impactful. 

Do you save, invest, or do both?

People will need to do both over their lifetimes. There are important considerations that go into the decision-making process but generally speaking, it is advisable that each and every time you decide to set up a saving or investment account, you ask yourself some important questions. 

The answer depends!

What should you do if you are trying to put aside some money for your parent's anniversary later this year?  How about a house you want to buy in 10 years?  Retirement in 40 years, what should you do then? For each and every saving and investing goal you have, you need to be able to easily define the goal, know when you want to achieve it, and also come to terms with how much risk you are willing to accept in the pursuit of the goal. Your parent's anniversary - you will need that money soon, so you should not take on much risk at all - It sounds like a savings account would work best.  Your retirement in 40 years - well, you have plenty of time to accept the ups and downs of the stock market, so the risk is acceptable - sounds like stocks, bonds, and mutual funds may be the best choice. 

Not undertaking this step where you ask yourself about the specifics of your goal, how long until you will need the money, and how much risk is acceptable can lead to financial mistakes. Trying to save for retirement by only putting your money in a savings account will lead to less than optimal results.  Putting the money you will need in a few weeks into the latest hot stock tip could mean that you lose most of your investment by the time you need the money.

 

Hopefully, you can see that saving and investing have many variables that need to be considered.  By being thoughtful and making a plan concerning your saving and investing, you will be sure that after you have worked hard for your money, your money will continue to work hard for you.  

 

Learning Checkpoint:

Imagine you have three buckets of money with $5,000 in each bucket.  Now think about how you should handle each one by asking yourself the three questions covered in this chapter.  What is your goal with each bucket of funds, when will you need the money, and how much risk will you be comfortable with.  How are your decisions shaped by your answers to these questions?