Why Invest in Stocks?
Once you have built your budget and built up your emergency fund, you will start to build up extra savings that go towards your future – and that future should include investing.
Simply put, when you have money to invest for an extended period of time (like 20 years or more), the stock market historically has provided the greatest return.
When most people are able to save money, they usually put it in the bank. Banks usually pay interest on the cash in your account, so if you have $1000 in your savings account and the bank pays you 3% interest then at the end of a year you will have about $1030. Once the savings balance gets bigger, a lot of people hope to earn more than what the bank is paying in interest, so they invest in real estate, stocks, bonds, and/or gold.
Historical Returns of Investments
While no one knows for sure what will happen in the future, a look at historical returns shows how these different investments have performed over time.
Here’s a chart of average percentage returns for the 30 year period from 1988 to 2018:
|US Stock Market||The average of all stocks trading in the US|
|US Large Cap||The average return of the biggest companies in the US (big companies that most people have heard of)|
|US Small Cap||Start-Up stocks – these have higher risk than bigger companies, but can also provide bigger rewards.|
|Short-Term Treasury||US Government bonds that expire in less than 5 years (and so your money gets “locked up” for a short period of time)|
|Long-Term Treasury||US Government bonds that expire in more than 5 years (and so your money gets “locked up” for a long period of time)|
|Long-Term Corporate Bonds||Bonds issued by companies for more than 5 years. The return is lower than stocks, but is also less risky (since if the company goes bankrupt, bond holders get paid before stock holders)|
|High Yield Corporate Bonds||Bonds with either very short duration (usually less than 5 years), or bonds on companies that are considered “Risky” – they have a high chance of going bankrupt|
|Real Estate||Investing in property and buildings, either to rent out or to re-sell at a higher price|
|Gold||Buying gold bars and coins|
From this chart we see that the stock market has performed the best – between a 900% and 1100% increase, depending on the security types. Gold performed the worst – one major reason being that gold tends to go up in price during years where there is low inflation, and down in years with high inflation.
So what does that mean? Over time there is a HUGE difference between 10% and 2%. Here is another way to look at it–this chart shows the growth of $100 for the 46 years from 1972 to 2018.
So, would you rather have $401 or $1,612! That’s a big difference for just $100. For $10,000 the results would be exactly 100x or $40,100 versus $161,200.
Finally, this chart looks at average returns from 1986 through 2018 and shows that the S&P 500 stocks were the best return, with a 12% average annual return – beating out both the large-cap stocks in the Dow Jones Industrial Average and the Small-Cap stocks in the Russell 2000 index.
In this table you also need to note the Standard Deviation column which measures the variance or volatility of the returns. Volatility means how much the stock’s price goes up and down in a short period of time. Long-term investors do not like volatility – most investors prefer to have their retirement account grow at a slow, but constant, rate rather than having huge spikes followed by huge losses.
It shows that Small Stocks also have the highest variance. This is why we say “over time” that stocks have the highest returns. If you looked at just one year or even five years, you might not see the same results because stocks are so volatile, but the longer the time period you have to keep the money invested the better it is to invest in stocks.
Simply put, if you want to maximize your personal net worth, if you want to be “rich”, if you want to be a “millionaire”, if you want to retire early–you must start saving and investing TODAY.
The earlier you get started, the more time your money has to grow. And the more time it has to grow, the bigger it will become.
Understanding how the stock market works and how to invest is so important because it determines how much your net worth will be when you retire. Are you going to leave your cash in your savings account at the bank all your life and earn an average of 3%? Or are you going to invest it in the stock market and try to earn 11%?