Basics of investing #1
Importance of investing and starting early
“An investment in knowledge pays the best interest” - Benjamin Franklin
Last week, I gave you a brief overview of how my journey into investing money began. Let’s continue exploring this topic by getting to know why investments are important for safeguarding your future.
Financial security is a very important part of our life that is overlooked by most adults because we have minimal exposure to this concept in our curriculum. Regardless of how our education system is, it is crucial to understand this topic and begin investing early for a care-free life ahead. Everyone has their own plans on how they perceive their retirement to be, but no one can deny that all these plans revolve around having enough money at an age where we might not be able to have a job or a stable source of income. In such a situation, the investments that you (hopefully) have been making since you were in your early 20’s will help you stay financially sound.
The second key thing here is to start early. I’ve read multiple books on investments and each and every author has stressed time and again on the importance of starting early. The reason for this is the concept of compounding. The money that you consistently put in to an investment medium, say a mutual fund, compounds every year. This seems very straightforward because all of us know what compound interest is. But, when you look at it laid out in numbers, you will be surprised at just how important starting early is. I was astonished when I did this exercise the first time.
Let’s take an example of a 20 year old undergraduate student who is maybe doing an internship or a part time job and earning $50 a month. Let us assume that their expenses take up $40 every month and that they invest the remaining $10 in a mutual fund that has a return of 10%, which is very conservative. Every year they will manage to invest $120. Over a period of 10 years, i.e. when at age 30, they will have invested $1200. That amount will now be $1912. If they continue to do this, at age 50, they will have $19,739 against a total investment of just $3600. That is the power of compounding and starting early.
Let us modify the previous example by only changing the age at which the person had started investing this amount. If they had started at 25 instead of 20, the final amount at age 50 would have been $11801. That is almost $8000 less! If they had started at 30 instead of 20, the final amount would be a measly $6873! You can cross check these numbers here if you are skeptical but I assure that I was also as surprised as you are (and I did cross check them). This is not a practical example by any means but I hope that it proves the benefit of starting your investments as early as possible and being consistent with them. As we have seen, starting with just $10 a month and being consistent with it for a long period of time, with the power of compounding, you will have a lot more money than you had imagined. Feel free to do the above exercise by substituting in your currency, estimating how much you can save monthly and look at the magic of compounding.
The ideal way to invest is to allocate a percentage of your annual earnings towards investments and keep increasing that percentage whenever you receive a pay hike. Now that you have hopefully agreed that investing is indeed important and starting early even more so, in the next article I’ll cover the topic of how I approached investing and made my first investment in a mutual fund. Until then, take care, be safe and happy learning✌