Everyone saw it happen, but no one saw it coming. The stock market crashed and sent investors running for cover. As a society, people are extremely reactive and have a tendency to be prisoners of the moment. Investing can be a very scary activity, because let’s face it; investing involves risk – the risk that you can lose the money that you’ve invested. And that fear can be made worse by a number of factors:
- Taking too much risk for your “risk tolerance” – not being aware of how much risk you’re comfortable with before you start losing sleep.
- Taking too much risk for your time frame – if you need the money in a year, or a few years, it’s probably not appropriate for investments.
- Not knowing enough about the investments you’re in, and whether they’re appropriate for your situation.
Scared people react, and market movements are a testament to that fact. So, what’s the solution?
Have a Plan
Financial security doesn’t happen overnight. There is no crystal ball. No shortcuts. No cheat codes. People work hard and grind to gain the financial security they desire, but often struggle. Planning is paramount to our financial success.
Planning for a financial goal inevitably starts with figuring out:
- How much does the goal cost, in today’s dollars?
- When do I need the money?
- How much do I need to save to hit that goal?
Here’s where investing comes in. You can, of course, save for a goal by putting the money in your mattress, in mason jars in the back yard, or any number of ways, but these options are more geared towards safeguarding what you already have. For larger and long-term goals, this safeguarding presents a problem: inflation. If you saved a dollar for a gallon of gas based on 1970 prices, how much gas is that going to buy you now? Let’s apply that to a college education 12 years from now (which, by the way, has a significantly higher rate of inflation than the goods we purchase). If your state school costs $15,000 per year now, you could save $417 per month, and have $60,000 in 12 years. Unfortunately, odds are 12 years from now costs will have risen and your 60k will no longer pay for the education you’ve saved for.
That’s why it’s smart for us to find a place to keep that money where we can earn something on it. Current interest rates at your local savings and loan are probably not very encouraging, but the 1 or 2% they can offer is infinitely better than the 0% you’re guaranteed if a mattress is your preferred savings vehicle. That being said, if what you’re earning is less than the inflation rate for your purchase, you’ll still be losing ground every year.
As we start looking for ways to earn more money, we start getting trade-offs. The mattress is relatively safe (barring a fire or burglary), and very liquid–you can access the money any time, but you get the least return for that. A savings account is a little less liquid–you have to go to the bank during working hours to access it, but you get a little interest in return. No matter how you slice it your investment will have trade-offs, but every extra bit of interest you earn helps, because it’s compounding over time. That means that not only is your money earning interest, but also the interest you earned, that’s plunked back into the account and that interest also earns interest. Over the long term, that compounding can make a huge difference.
For example: saving $417 per month for 12 years, gives you just over $60,000, not counting the taxes you would need to pay each year on the earnings.
Earn 1% and after 12 years you’d have $63,772.
Earn 2%, and you’d have $67,804. Which is a bigger gain than the difference between 0% and 1% – that’s the effect of compounding.
Think of compound interest as the snowball effect that happens when you put your money to work.
So, now you might be seeing why some people are willing to take some risk, as that risk brings the potential for even higher returns. What’s the trade-off? In general, the higher the potential return of an investment, the higher the risk or probability that you might lose money in any given year. There’s also the risk that the markets, or just the investments you choose, won’t perform in the future like they did in the past. Regardless of what you decide to invest in we know there are a myriad of trade-offs, so before investing you should always ask yourself – is the juice worth the squeeze?
The examples above are hypothetical, and for illustrative purposes only. They are not representative of any particular investment. Investing involves risk, including the potential for loss of principal. Past performance does not guarantee future performance. Securities can be offered solely by representatives registered to offer such products through a broker/dealer. Bryan Pritchard is a registered representative of Equity Services, Inc.(ESI). ESI, Member FINRA/SIPC, is a Broker/Dealer affiliate of National Life Insurance Company.