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Investing in real estate and the stock market are the best ways to grow your money. Unlike real estate, the stock market gives investors the ability to quickly buy, hold and sell assets with very little effort. People with a medium to low debt to income ratio, should begin investing as soon as possible to create wealth. If you have debt with interest rates above 6% to 8%, it is recommended that you pay down the debt or refinance to get a lower interest rate and payment before investing. Before starting an investment account, begin saving to create an emergency fund with at least 3 months of expenses. In the event of an emergency, you don’t want to be forced to sell an investment before you are ready.
Investing even as little as $50-$100 a month is a good to start. If you invest $50 to $100 every month at an 8% return, in 20 years you will have a total of $29,000 – $58,900.
Below are six reasons to begin investing immediately.
1) A savings account is a negative investment.
The main purpose of a savings account is to have money on hand for unplanned expenses and unexpected events. In addition to an emergency fund, some choose to have a second savings account for personal expenses such as a new pair of shoes or a weekend trip. Regardless of your personal preferences a savings account is only meant to serve a short-term need.
Every year we have something called inflation. Inflation is the rate at which the price of goods and services rise. Explained another way, when we go shopping to buy food and clothing, the prices go up every year. If you look back 5 to 10 years ago, a bag of potato chips cost $0.50. Now a bag of potato chips costs more than $1.00. We used to be able to buy two bags of potato chips with $1.00, now we can’t even buy one! That’s the effect of inflation.
During times of economic crises such as the financial crash of 2008, the inflation rate can be negative. In 2017, the inflation rate is around 1.9%. However, most of the time the inflation rate is around 3% per year.
When comparing the yearly inflation rate to the interest rate earned on a savings account, the amount of money we earn per year can be calculated as:
1% interest on savings – 3% inflation rate = -2% investment return
When we put our money in a savings account, we are actually losing value every year. We haven’t even considered the effect of negative compounding interest. Placing all of your money in a savings account is the same as placing your money under a mattress.
To see an example of the amount of money that you could have after you invest it please see Bank Rate’s Return on Investment Calculator.
Note: The amounts below may be slightly different than the amounts you get using Bank Rate’s calculator. The rules we are using are slightly different. The main point is that investing money is better than letting money sit in a savings account.
Amt Saved per Month
Amt in Savings Account w/o Interest
Amt in Savings Account w/ Interest (no inflation)
Amt in Savings Account w/ Interest (Adj. for Inflation) ⇓
Total Amt when Invested in Stock Market (no Inflation)
Total Amt when Invested in Stock Market (Adj. for Inflation)⇑
This table assumes 1% interest rate on savings; 3% inflation rate; 8% return on investment.
2) Investing in an IRA account can increase the amount of money you save for short-term goals.
Buying a home
For 2017, the maximum annual IRA contribution is $5,500 if you are under 50 years old. Contributions to a Roth IRA are not tax deductible. However, contributions to a traditional IRA are deductible if your gross income is less than $72,000 per year. If you are a first-time homebuyer, you can withdraw up to $10,000 from your IRA account without a penalty to cover the cost of buying a home. The IRS defines a first-time homebuyer as anyone who has not owned a home within the past two years.
Many people think withdrawing money from a 401(k) to purchase a home is tax-deductible. This is a mistake. Money withdrawn directly from a 401(k) is subject to a tax penalty. The best way to get around this is to withdraw money from your 401(k), and place it in an IRA account. Then you can withdraw up to the $10,000 limit from the IRA account to buy a home without a tax penalty.
Going to college or trade school
Money withdrawn from an IRA account to pay for qualified education expenses such as college or trade school is also tax deductible. The school you are attending must be eligible to participate in the US student aid program to receive the deduction.
Medical expenses and medical insurance premiums
In the event you become unemployed, you can withdraw a limited amount from your IRA account to cover medical insurance premiums and unreimbursed medical expenses without a tax penalty.
As always, please consult a qualified financial professional, to determine how an early withdrawal from your IRA account will affect your tax situation.
3) Certificates of Deposit accounts or CDs are slightly better however there’s still a catch.
A CD is the same as a savings account but with more restrictions. For 2017, CDs are paying up to 2.5% interest per year. If we go back to point #1 above which discusses the annual inflation rate, a CD is a neutral or negative investment.
If we subtract the inflation rate from the rate earned on a CD, the amount of money earned each year is:
2.5% interest on CD – 3% inflation rate = -0.5% investment return
The equation above shows that we still lose money when we place it in a CD on a long-term basis. In addition, most CDs don’t allow you to withdraw money early without a penalty. On the other hand, a stock can be sold whenever you choose.
4) Investing can help pay off student loan debt fast.
When I finished grad school, I racked up almost $120,000 in student loan debt. Ten years later I paid off all of my high interest loans through investing. Federal student loans are typically considered “good” debt. Depending on your circumtances, it can be more beneficial to invest instead of paying off student loans with federal student loan interest rates below 5%.
5) Investing can provide financial security during difficult times and life transitions.
If you are ever in a circumstance where you need to take time off from work or leave your job, an investment account can serve as an additional emergency fund. Although using funds from an investment account may not be tax-deductible, having additional money available can provide peace of mind and options during difficult times.
6) The opportunity cost of not investing is high!
Some years the investment return in the stock market is 20%. Other years the investment return is negative. The average annual investment return for the stock market is 8 to 10% in the long-term. The opportunity cost of not investing in the market is the loss of the 8% to 10% annual return you could have earned by investing.
If we compare the amount earned from investing in the stock market to the inflation rate, the amount earned is 5% to 7%.
8% to 10% annual return – 3% inflation =5% to 7% investment gain
Investing protects your money from inflation. This is the reason the stock market is one of the best ways to build wealth.