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‘Why Should You Invest?’ is the topic of our first session today. A frequently asked question that we will attempt to deconstruct and explain for you before moving on to other topics such as: Can you afford to invest? When is the best time to begin investing? What kind of an investor are you? What should your investment objectives be? Selecting what to invest in, how to pick a stock, investing psychology, and much more.
First and foremost, let’s talk about why people invest in the first place. Its purpose is to make money. If you play a sport or an instrument, unless you’re Cristiano Ronaldo or Beyoncé, odds are you’re not doing it for money and are instead doing it for fun. Yet that is not the case when it comes to investing. Individuals invest to make money, to beat inflation, and to accumulate wealth over time.
We at eToro have noticed a significant increase in the number of people wishing to invest in recent years, and we believe it is our responsibility to give as much free educational content as possible.
So let’s not waste any time and get right to work.
Why Should You Invest?
The First Reason You Should Invest
A 2020 survey found that one-third of Britons owned stocks and shares, a 50% rise from 2018, while an earlier this year report found that 80% of Gen-Z are now investing. However, it is worth noting that this report showed a massive 64% of the 16 to 25-year-olds surveyed have experienced some form of investment loss, which is why here at eToro we want to give you all the opportunity to learn how to navigate the markets and become a better and more knowledgeable investor.
Investing in Stocks to Combat Inflation
Should you invest to combat inflation? Let us return to the reason why individuals invest. You might simply keep your money in a bank, but that means you’re losing money every year due to inflation. Have you noticed that prices are rising year after year? Rail tickets, gas bills, grocery bills, and even the price of a Freddo chocolate bar are all examples of inflation at work. Inflation is just one of the reasons individuals invest in order to beat it. But does investing outperform it?
While previous performance is no guarantee of future results, stocks have traditionally outperformed other asset classes in terms of returns. An examination of holding periods between 1926 and December 31, 2017 revealed that the annualised return for a portfolio consisting solely of companies in the S&P 500 index was 10.22% – far higher than the average inflation rate of 2.89% for the same period2.
It is worth remembering that you could begin investing in a year when the stock market does not rise or when inflation exceeds your profits. Long-term thinking is essential, and the data and statistics support this.
As previously stated, the S&P 500, the world’s largest invested stock market, has averaged roughly a 10% annual return over the last century and has positive yearly returns more than 70% of the time. This does not imply that you can expect 10% increase every year; you could make a profit one year and lose the next. But, if you invest for the long term, you want these gains and losses to average out over time, ideally ending in the black at the end of the investing period.
Now that we have some statistics to back up our arguments for investing, let’s take a look at what that may look like for us in the future if we started today.
Considering the average returns of the US stock market, if we begin by investing $200 or pounds every month for the following ten years at a 10% rate of return, our investment would be worth $41,851. That is not a small number, but let’s see what happens if we shift the time frame from 10 to 30 years.
The investment would be worth $459,832 with the power of compounding. Again, we are not guaranteeing these returns, but if history is any guide, this is what they could look like. The maths demonstrates the need of investing on a regular basis and having a long-term investing mindset, which will be covered in a later session.
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Interest on Interest: Compounding
Should you invest for growth? Let’s dig a little deeper into compounding now.
According to legend, Albert Einstein declared, “Compound interest is the eighth wonder of the world” and “Compound interest is the most powerful force in the cosmos.” While we’re on the subject of famous people, here’s another wonderful one from Benjamin Franklin: “Money makes money. Because money that makes money is money that makes money.” Yeah, he was on something for sure.
Say you had £100,000 today (which would be fantastic) and want to invest it with a 5% annual return. The £100,000 would earn £5,000 in a year. If you reinvest all of your portfolio gains, you may make £5,250 in the second year, £5,512.50 in the third year, £5,788.13 in the fourth year, and so on.
But your investments can only benefit from compound interest when the returns are reinvested. If you took off all of the profits on your £100,000 investment, you would only be earning £5,000 each year.
The consequence of not reinvesting returns may appear modest in the short run. But, wealth creation requires time and patience, so extrapolating those returns over 30 years reveals a significant difference in wealth between an investor who reinvested their profits and an investor who did not.
Your initial £100,000 investment rises to £432,194.24 (or 4.32 times what you started with) after 30 years of reinvesting earnings. If you withdraw your returns, your investment would only increase to £250,000 (or 2.5 times what you started with), resulting in a loss of over £182,000 by not reinvesting your profits.
As our calculations illustrate, compound interest can work as a catalyst for your investments. It can help your money increase faster, bringing you closer to your financial goals, especially if you start early and opt to leave your investments for a long enough period of time.
Putting Money Aside for the Future
Should you invest for the future? Saving for the future is another reason why individuals invest. Whether it’s for early retirement, a house, or something for their children, investing wisely can be helpful. Now, you may ask, ‘Why don’t I just leave my money in the bank?’ We mentioned inflation previously, but another factor to consider is that interest rates are historically low right now. Interest rates are no longer above 10%, and you can no longer earn a return on your savings.
Conclusion: Should You Invest?
In conclusion, why should you invest? As previously said, people do so for a variety of reasons, the most important of which is to make money. With interest rates so low, investing for the long term can be a wise move if done right. Another important motive is to try to keep up with and combat inflation.
We looked at the statistics and discovered that the return on the US stock market, for example, is around 10%, which is higher than the average inflation rate of 2-3% per year.
Whether you decide to invest for early retirement, to buy a house, or simply to live more comfortably, there are a number of factors to consider to ensure your success.
As we move through the several classes, we will talk about investing ideas in more detail and even address some extra bonus stuff like ‘should I invest during a recession?’. Our goal here is to provide you with the information you need to get started on your investment adventure.
Go on to our eToro Summer School curriculum, where we’ll go over investing in further depth. See you in the next session when we examine ‘can you afford to invest?’.
Your capital is at risk. Other fees apply.
