Why Should I Invest?

Jan 9, 2023

Introduction

Investing is the act of allocating resources, usually money, with the expectation of generating an income or profit. The “why” in “Why should I invest?” is answered by the compelling potential for financial growth that investing offers. The most successful investors understand that investing is not just about making money; it’s about making your money work for you. When you invest, you are setting your money into motion and allowing it to generate more.

The concept of compound interest is a driving force in investment growth. When you invest your money, it can earn interest. If you leave that interest in the investment, it too can earn interest. Over time, this cycle can snowball, leading to exponential growth in your initial investment. For example, if you invest $5,000 at an annual interest rate of 5% in 25 years, your investment would grow to over $17,000 without any additional contributions from you.

Investing is also a powerful tool for achieving long-term financial goals. Whether it’s buying a home, saving for your child’s education, or planning retirement, investing can help you reach these milestones. The potential returns from investments often outpace traditional savings methods. For instance, the average annual return from the S&P 500, a benchmark for U.S. stocks, has been around 10% since its inception. In contrast, the average interest rate on a savings account in the U.S. is less than 1%.

Moreover, investing gives you control over your financial future. It allows you to take advantage of opportunities leading to wealth accumulation and financial independence. It can provide an income stream and make you less reliant on your regular employment for income. This potential for financial growth and independence is why investment is not just an option but a necessity for anyone serious about increasing their wealth.

Investing, therefore, is empowering. It’s a step towards taking control of your money and your life. It allows you to grow wealth, achieve financial goals, and gain financial freedom. So, the answer to “Why should I invest?” is simple: for the potential of financial growth and its power.

The Proven Link Between Investing and Wealth Creation

Investing is a strategic approach to multiplying your wealth. It’s about planting and nurturing your financial seeds to grow and flourish. When you ponder “Why should I invest?” consider the potential for financial growth that investing offers. It’s not merely about accumulating more money but about leveraging your money to work for you.

In investing, the term ‘compound interest’ is a key player. Compound interest is essentially ‘interest on interest,’ and it can cause a snowball effect that allows both the initial amount of money and its accumulated interest to grow over time. For instance, if you were to invest $1,000 with an annual interest rate of 5%, you would have $1,050 at the end of the year. In the second year, interest would be applied not just to your initial $1,000 but also to the $50 gained in the first year. This process repeats over time, leading to significantly increased returns.

This power of compound interest is why Albert Einstein was moved to call it the “eighth wonder of the world.” It’s a force that works tirelessly in the background, steadily increasing your wealth without requiring additional effort or input.

Investing also plays a crucial role in achieving your long-term financial goals. Whether you aim to buy a house, fund a child’s education, or secure a comfortable retirement, investing can help you reach these objectives. This is because the potential returns from investments, especially over the long term, generally surpass those from regular savings.

Furthermore, investing instils a sense of financial security and independence. By creating additional income streams, investing can reduce reliance on your primary job, provide a safety net, and open doors to new opportunities.

So, in response to “Why should I invest?”: investing offers the potential for financial growth, the realisation of long-term goals, and the opportunity for greater financial freedom. When used wisely, it’s a tool that can elevate your financial status and pave the way for a secure and comfortable future.

Investing as a Hedge Against Inflation

Inflation, often described as the silent thief, eats away at the value of your money over time. A candy bar that cost only a few cents in the 1960s now costs over a dollar, thanks to inflation. This continuous rise in the general level of prices, where a unit of currency effectively buys less than it did in prior periods, is a reality we all face.

The U.S. Bureau of Labour Statistics reported an inflation rate of 2.3% for 2020. At a glance, this might seem insignificant, but the impact of inflation becomes clear when looked at over a longer period. Consider having $100,000 in a safe, earning no interest. In 20 years, with an average annual inflation rate of 2.3%, the purchasing power of this $100,000 would fall to approximately $60,000. In other words, the safe choice of keeping your money out of the market can lead to a significant loss of purchasing power over time.

This is where investing comes in. By investing in assets that provide a return greater than the inflation rate, you can protect your money from losing value. For example, if you invest in stocks that return an average of 7% per year, you earn about 4.7% after adjusting for inflation.

Investing in diverse assets, from stocks and bonds to real estate and mutual funds, can provide a hedge against inflation. Each of these assets has its own potential for return and level of risk, offering various opportunities to outpace inflation.

Investing also offers the opportunity to increase your wealth in real terms. As your investments grow, they not only maintain their purchasing power but also provide an increase in wealth that boosts your standard of living.

So, think of investing not just as a way to grow wealth but also as a necessary strategy for preserving your purchasing power and protecting against the erosive effects of inflation. Investing, therefore, is a form of financial self-defence, ensuring that your money retains its value in a world of rising prices.

The Magic of Diversification

Diversification is a fundamental principle in investment, often encapsulated in the adage, “Don’t put all your eggs in one basket.” When you diversify your investment portfolio, you spread your money across a variety of assets, such as stocks, bonds, real estate, and commodities. This strategy balances risk and reward by allocating investments according to your financial goals, risk tolerance, and investment horizon.

A diversified portfolio can reduce the potential for significant losses. If one investment performs poorly, another in your portfolio is likely performing well, offsetting the losses. In this way, diversification helps to smooth out the volatility in your portfolio, making for a less bumpy investment journey.

This was demonstrated in a 2020 study by Morningstar, which found that a diversified portfolio reduced volatility by 20% over 20 years compared to a single-asset portfolio. This shows that diversification doesn’t just reduce risk; it can also lead to more stable returns over the long term.

Diversification not only involves investing in different asset classes but also within those classes. For example, you could diversify within the asset class of stocks by investing in different sectors such as technology, healthcare, or finance. You could also diversify geographically, investing in domestic and international markets.

Moreover, diversification plays a crucial role in maximising returns. Different assets perform well under different market conditions. By spreading your investments across various assets, you are more likely to be exposed to top performers at any given time.

So, when pondering, “Why should I invest?” consider the magic of diversification. It’s a strategy that allows you to navigate the unpredictability of the markets, reducing risk while maximising potential returns. It’s a way to ensure that no matter what happens in one area of your portfolio, you have other investments that can help counterbalance the impact.

The Allure of Passive Income

A significant advantage of investing is the potential for passive income. Passive income refers to earnings derived from a source other than a traditional 9-to-5 job. It’s an income that doesn’t require your direct involvement or daily commitment. Dividends from stocks, interest from bonds, rental income from properties, or even royalties from creative works are all passive income.

The allure of passive income lies in its ability to provide financial stability while freeing up your time. Unlike active income directly tied to your time and effort, passive income flows in even when you’re not actively working. This allows you to pursue other interests, spend more time with loved ones, or even focus on more investing opportunities.

Generating passive income through investing can also add a layer of financial security. If your active income suddenly ceases, having a passive income stream could help cover daily expenses and prevent financial distress. Furthermore, it can also contribute to your overall wealth, accelerating your journey towards financial independence.

To illustrate, consider the dividends from stocks. When you buy company shares, you’re buying a piece of ownership in that business. Some companies distribute a portion of their profits back to their shareholders as dividends. These earnings can be reinvested to buy more shares, creating a cycle of compounding growth, or used as a steady income stream.

Similarly, bonds pay regular interest, and rental properties can provide a consistent influx of rental income. According to the U.S.. Census Bureau, the median passive income for American households was over $1,500 in 2020.

Investing offers an avenue to generate passive income—a financial buffer that complements your active income. It’s a step towards financial freedom, allowing you to earn money with minimal ongoing effort. It’s a way to make your money work for you in the truest sense.

The Contrarian Approach to Investing: Why Swim Against the Tide?

Investing is as much about mentality as it is about money. It’s about understanding market trends, analysing data, and making informed decisions. But it’s also about daring to think differently, to swim against the tide when it seems most counterintuitive. This is where the contrarian approach to investing comes into play.

The contrarian approach is a strategy that rejects the herd mentality. It involves identifying and capitalising on investment opportunities that the majority may overlook or underestimate. Contrarian investors buy assets when others are selling and sell when others are buying. They believe that mass psychology can lead to inflated prices during periods of optimism and undervalued prices during periods of pessimism.

This approach is not about being contrary for the sake of it. It’s about critical thinking, careful analysis, and a deep understanding of market fundamentals. It’s about identifying discrepancies between the intrinsic value of an asset and its market price. For instance, during periods of market pessimism, assets may be sold off indiscriminately, leading to price drops that don’t reflect the asset’s underlying value. Contrarian investors recognise these opportunities and buy these undervalued assets, anticipating a price correction.

On the flip side, asset prices can be inflated beyond their intrinsic value due to widespread optimism during market exuberance. Contrarian investors can recognise these inflated prices as a selling opportunity, anticipating a future price drop.

So, when you ask, “Why should I invest?” consider the potential profits from a contrarian approach. By thinking differently and daring to swim against the tide, you can spot and seize opportunities others may miss. It’s a strategy that, when executed well, can lead to substantial profits. Remember, investment isn’t always about following the crowd; sometimes, the crowd is wrong. And it’s in those moments that the contrarian investor can thrive.

The Thrill of Investing: The Game-Stop Saga

Investing can sometimes feel like an exhilarating roller coaster ride filled with highs, lows, twists, and turns. A prime example is the recent GameStop saga, which unfolded like a Hollywood thriller and captured the world’s attention.

In early 2021, an army of individual investors congregated on a subreddit called r/WallStreetBets. Collectively, they decided to buy shares of GameStop, a struggling video game retailer. The motivation behind this move was twofold: to profit from the subsequent rise in stock prices and to squeeze hedge funds that had heavily shorted the stock, betting on its price to fall.

The stock price skyrocketed as these Reddit investors began buying up GameStop shares. The price surge caused significant losses for the short-selling hedge funds, leading to a market phenomenon known as a “short squeeze.” This, in turn, drove the stock price even higher.

For many of the individual investors involved, the returns were significant. Shares that had been bought for as little as $20 were, at one point, worth over $480. However, this dramatic rise was followed by an equally dramatic fall, illustrating the volatility and risk that can accompany such speculative investing.

While the GameStop saga is an outlier event and not a typical investing scenario, it underscores the potential for substantial gains in investing. It also highlights the power of collective action and the impact of social media on financial markets.

However, it’s essential to remember that investing is not just about the thrill of such extraordinary events. It’s about building wealth over time, understanding the markets, and making informed decisions. While the GameStop saga was an exciting chapter in the investing world, successful investing is usually a long-term game, requiring patience, strategy, and a balanced approach.

The Future of Investing: Cryptocurrencies and Blockchain

The rise of cryptocurrencies and blockchain technology has revolutionised the investment landscape. Bitcoin, the largest cryptocurrency, will be appreciated by over 300% in 2020. Moreover, blockchain, the technology behind cryptocurrencies, is being adopted across industries, offering numerous investment opportunities.

In conclusion, the question “Why should I invest?” is answered by the compelling benefits of financial growth, diversification, hedging against inflation, generating passive income, and the thrilling potential of market dynamics. With a calculated approach and an understanding of market psychology, investing can be a rewarding journey leading to significant financial growth.