Most people dream one day of being able to give up their day job to enjoy a comfortable retirement. Other financial objectives may include being able to afford a bigger house, or being able to put kids through college. In order to meet these medium to long-term objectives, there will normally be a need to grow our wealth. Unfortunately, stuffing money under a mattress won’t achieve this and even placing your money in a savings account is unlikely to earn enough interest to meet your needs. Therefore, most individuals will need to engage in some form of investment if they are to generate sufficient returns to fund their future needs.
What is investment?
Before we go on to explore various reasons why you should invest, it’s worth taking a moment to clarify what types of financial instruments are classed as investments. When people hear the word “investment” they often think about the buying and selling of shares on the stock market. This is indeed a common form of investment but it’s not the only type. You can invest money in government bonds, you could buy gold or fine art, or you could invest your money into buying property. The definition of “invest” is simply “to commit (money or capital in order to gain a financial return”. (Source: http://www.thefreedictionary.com/invest ). And, although you might be able to realize an overnight profit, there is usually a presumption that investment is something that is done over a sustained period of time, in order to secure a meaningful return.
Reasons why you should invest:
1. Creation of additional income:
One of the principal reasons that people invest money is to generate additional income, either in the short term or in the longer term. An example of how you could generate short term income is to buy shares that will have a high likelihood of paying out a regular income in the form of dividends. An example of investing for a longer term income is making payments into a pension scheme. As well as the fact that it’s always nice to generate additional money, another benefit of investing is that it makes you less reliant on a sole source of income. If you were to lose your job, or suffer a pay freeze, then it’s reassuring to know that you can expect to have some income coming in from dividends, savings interest, or a pension.
2. Generation of additional capital wealth:
If you spend $10,000 on buying shares, then that $10,000 amount is referred to as your capital sum. It is, in effect, the starting value of your investment. Over the course of owning those shares you may earn some annual dividend payments on them, which is great. However, many investors are equally or more interested in the potential for capital growth.
To illustrate this, let’s image that the shares you bought cost $10 each. With your $10,000 expenditure, you would have obtained 1,000 shares in the company. Now, let’s imagine that the share price goes up from $10 to $20 over 5 years. Suddenly, the value of your shares will have doubled from $10,000 to $20,000! Your capital growth on this share would therefore be $10,000 (i.e. the new value of $20,000 minus the original purchase price value of $10,000).
Similarly, if you were investing in something like art or gold, it would be capital growth that you would be seeking, since those investment items don’t generate regular income payments.
3. Combat the effects of inflation:
We’ve all heard our parents or grandparents talking about how they purchased their first home for a ridiculous-sounding amount of money. However, the chances are that the amount they paid was just as challenging for them to fund as the amounts that first time buyers are faced with today. The reason for this is that price inflation means that the dollar or pound (or any other currency) will buy a lot less today than it did 20 years ago.
Inflation is being talked about a lot at the moment in the press as it’s at very high levels. At the time of writing it is at 3.5% in the United States and a very scary 5% in the UK. Anything over 2% is bad news for savers. For example, you would currently have to get a savings rate of 3.5% (in the US) or 5% (in the UK) after tax in order for your savings just to retain their value, never find see any growth in wealth.
Investing can help to mitigate against the worst effects of inflation by offering the potential to generate inflation-beating returns. However, investors always need to be aware that the potential of high returns goes hand in hand with the risk of loss of money. For example, those shares you purchased for $10 per share may drop to $5 in value, leaving you with half the money you started with.
4. Prepare for a day when you won’t be able to work:
When you’re in the prime of your life you may well be earning more than enough to meet your everyday needs and you may wonder why you should have to sacrifice some of your current spending power to put money into a pension scheme or into stocks and shares. However, the average life expectancy rates are continuing to rise and you may expect to live into your eighties or even longer. It’s sensible, therefore, to prepare well in advance so that you are in a position to enjoy a comfortable lifestyle in your later years.
5. Be able to take early retirement:
Many people are resigned to the fact that they will need to work until the normal retirement age (which varies in differing countries) but how much better would it be to be able to retire early. For this to be a possibility, the chances are that you will have to have committed heavily (and early) to building a retirement nest egg. It is worth remembering, though, that every dollar or pound that you invest should be taking you closer to being able to retire!
Investing is vital for those who want to maximise their wealth and ensure that they can enjoy a comfortable standard of living when they retire. However, investing is not without risks and each individual needs to weigh up both the risk and potential reward and work out what level of risk they are comfortable with. It can be worth speaking to a financial adviser to better understand all the options that are open to you. Remember, too, that investing works best when it is viewed as part of a long-term strategy. Anything that claims to offer a get-rich-quick outcome deserves scepticism and most investors who get rich do so slowly by prudently investing regular affordable sums over a long period of time.