Many of us already assume that investing is a wise thing to do—it’s what every financially responsible person does. Yet, not everyone who believes it does it. Why is that? Most people don’t have enough education on the subject. They equate “investment” with risk and “saving” with prudence, not realizing that the choice is actually between financial growth, on one hand, and slow financial erosion, on the other.

When faced with the prospect of growth or loss (we’ll cover later in this article how saving is a form of loss), what other choice might you have, if not for investing carefully and wisely?

Continue reading to learn how investing is the only way to achieve real financial growth. 

The Truth about Saving vs. Investing Your Money

Many would-be investors equate investing with risk. Sure, while some types of investments are riskier than others, you shouldn’t generalize too quickly. The truth is, different investment styles come with varying degrees of risk and safety. In short, how you invest your money can be equally as important, if not more so, than what you invest in.

So, why not invest in cash—a supposedly “riskless” investment? 

Money Saved Isn’t Always Money Earned

Suppose you saved a boatload of cash, enough to pay yourself $50,000 annually for several years in the future. You figure that’s a decent amount to live a comfortable lifestyle. If inflation creeps up by the historical benchmark of 3% a year, then in two decades, you’ll need $90,000 to cover your expenses. Add another 10 years and you’re looking at over $120,000 to match your purchasing power today.

So much for your $50,000 a year. 

Cash saved isn’t money earned; in fact, it’s purchasing power lost. And this loss is perpetual. Just check any inflation calculator to get a historical perspective. You can outpace this slow erosion, but you’ll have to invest to make real growth happen.

You may be asking, “What if I don’t have enough money to invest?” or “Will the little money I do have make a difference?” Many new investors are under the impression that a greater level of wealth must precede investments, at least those that count. It’s time to explore and challenge that assumption.

Which Came First: the Wealth or the Investments?

Let’s narrow things down and just talk about stocks for a moment. In 2001, the wealthiest 10% of Americans owned 71% of the stock market. In 2013, that number grew to 81%. And in 2016, that figure increased to 84%. (Keep in mind that we’re talking about roughly 20 million Americans here.)

The point here isn’t to highlight wealth inequality. Instead, it brings up a “chicken-or-the-egg” type of question: Was the 10% who owned 84% of the market in 2016  already wealthy, or did they slowly accumulate enough assets to join the 10%?

The likely answer is both. 

If money saved is money slowly lost, and if money spent is money immediately lost (unless you’re using it to make more money…hence, investing it), then investing your money is your only chance toward attaining financial growth beyond your current income. 

Increasing your paycheck—say by getting a raise or a higher position—is great. Unfortunately, however, you can’t do much more than that unless you take on some investment risk. And here’s the kicker: someone at a relatively lower income level than you can surpass your wealth by investing wisely and accumulating compound growth.

Understanding the Effects of Compound Growth

It’s one thing to invest a sum of money and collect profits (or sustain losses). It’s quite another thing to reinvest profits at the end of a trading or investing cycle.

Consider this scenario: two investors, both of whom experience the same level of positive returns over a five-year period, invest $50,000 into their account.

The first investor collects his profits at the end of each year, keeping his original 10k investment in play. The second, allows her returns to compound growth. How might both fare at the end of the five year period?

% Return Investor 1 Return Investor 2 Reinvestment
20% $50,000 $10,000 $50,000 $10,000
60% $50,000 $30,000 $60,000 $36,000
15% $50,000 $7,500 $96,000 $14,400
5% $50,000 $2,500 $110,400 $5,520
30% $50,000 $15,000 $115,000 $37,776
  • After five years, Investor 1 has an ending balance of $115,000; 130% above his initial investment.
  • Investor 2, on the other hand, has an ending balance of $150,696; 201% above her initial investment.

As you can see, compounding growth can be a powerful tool toward achieving increasingly higher returns. This, of course, entails risk, leaving people wondering if it’s worth the game of odds.

Why Should I Even Consider Risking My Money?

Risk is a simple concept, yet the act of engaging and managing risk can present you with a complex labyrinth, or a proverbial rabbit hole. First, you must realize that no worthy enterprise or venture comes without even the slightest degree of risk. You can succeed or fail, whether we’re talking about a project at work, a fitness goal, an attempt to cook a meal, a real estate purchase, or, in our case, an investment.

But not all investments present the same type or level of risk. Some are riskier than others. For instance, buying a futures contract (which is highly leveraged) presents a different risk from, say, buying a few shares of an S&P 500 ETF.

When getting started with investing, the mistake many people make is focusing too much on the investment and not enough on his or her investing practices. If you choose to concentrate your investments in one asset class, one sector, one commodity, or one stock, your investing practice may be much riskier than diversifying your portfolio across a wide range of non-correlated assets. 

Often, how you invest can make the biggest difference. In other words, one of the biggest risk factors you’re likely to encounter is your own investing behaviors and actions. Here are two simple rules of thumb when it comes to managing risk:

  • Diversify your portfolio: Don’t concentrate all of your investible funds into one area. In short, expand your assets across a wide spectrum of market exposures.
  • Focus on earning: Try to set up your investments in a way that your positive payoffs are greater than your negative payoffs.

Let’s take the last point. Suppose you came across an aggressive algorithmic currency system that has a history of making outsized returns, say around 75% annually. The problem, however, is that it has generated deep historical drawdowns, sometimes as low as -50%.

75% is a high return, but can you imagine losing half of your capital in the process? 

That’s a risky system, but one that might be worth pursuing. So, what might you do? If you were smart, you’d allocate only a small portion of your portfolio to that system, anywhere from 5% to 10%, leaving up to 90% of your portfolio to more traditional and less-risky investments.That way, if you lose half (or more) of your capital, you’ve reduced your exposure to a small fraction of your portfolio. 

Then, if you do generate 75% return or more, you’ll find yourself further along than if you had simply passed it by.

Investing Money: Your Takeaway

Investing is one of the only ways to achieve rapid or outsized growth beyond your current income. Saving, on the other hand, guarantees slow loss, as inflation is an incessant factor. Don’t be afraid to take risks; it’s present in almost everything you do. But manage risk so that the likelihood of positive returns may be exponentially greater than your negative outcomes. 

If you want to learn more about investing, or if you have any questions, come talk to us, or join our investment resource network.