When it comes to investing money in the stock market, time is your greatest ally and your greatest enemy. The longer you are investing money the greater likelihood you’ll generate great wealth. Shortening that time period by just a few years could significantly reduce the amount of wealth you’ll create.
That’s why it’s important to get started early – in fact, the earlier the better. Time is the most critical element in the investing equation. It doesn’t matter if you are a high school student making minimum wage at a summer job, a college student paying your way through school or married with your first child on the way. The earlier one can begin investing, even in small amounts, the more one can maximize big returns in the long run.
The following examples demonstrate this point:
“Person A” begins investing at age 19. She contributes $150 per month ($1,800 per year) for 8 years, until the age of 26. The total amount of money invested equals $14,400. If she were to average 12% return per year, by age 65 that investment would have grown to $2,264,026. Keep in mind that is without investing another dollar after the age of 26.
“Person B” begins investing at age 27. He contributes $150 per month ($1,800 per year) for 39 years, until the age of 65. The total amount of money invested equals $70,200. If he were to average the same 12% return, by age 65 he would only have amassed $1,580,051.
Person B invested $55,800 more actual dollars over the investment period yet fell $683,975 short of the mark achieved by Person A…all because Person A started investing earlier.
You may argue that 12% return is impossible to achieve. To that I’d say two things:
1) It’s more about the principle of time than the actual numbers and…
2) Even if you only average 8% you’d still be sitting pretty. (To play with your own figures, use the investing calculator here.)
Don’t Put the Cart Before the Horse
What a difference time can make! However, you should only start investing money when you are actually able to start investing. Trying to force investing before other financial obligations are taken care of will lead to frustration and potential setbacks.
For my money there are two financial milestones that must be met – and one caveat to consider – before investing should begin.
Milestone #1: Have paid off all non-mortgage debt
Getting out of debt should be a higher priority than investing money. Yes it will take time to pay off all the non-mortgage debt and that will eat into the time variable in the investing equation. There are several reasons though why I believe this is the right path to take.
First, growing your wealth is a psychological journey. In your mind you see two things: 1) where you want to go and 2) all the barriers that are keeping you from getting there. One of those barriers is debt that comes in all shapes and sizes – from credit cards, school loans, car payments and a host of other things.
Getting out of debt removes that barrier and gives a much needed psychological boost. When a person is in $50,000 of consumer debt it never seems like they will reach their financial goals. With that debt erased and the burden it placed on their lives removed they gain hope their destination is reachable.
Not only does it produce hope, it builds confidence. Let’s not sugarcoat it here – paying off debt is hard. For many it’s a real long journey filled with emotional ups and downs. Often times it feels like you will never pay it off.
But paying off debt builds confidence in your ability to achieve financial goals when you can look back and see what you’ve accomplished. That confidence will be an important asset as you begin to explore more advanced personal finance issues like investing.
Milestone #2: Building a fully funded emergency fund
An additional milestone to reach before investing is to save enough money that would cover at least 3 – 6 months of expenses in case there is a short or long-term emergency. This makes sense because if you have investments but no emergency fund where will the money come from to pay for those emergencies when they arrive?
In that scenario the funding for emergencies can only come from two places: new debt or from selling investments to raise the capital to pay for the emergency.
Neither of those options would be wise financial move. Going into debt to fund emergencies is a step in the wrong direction. Your financial picture is taking a step backward at that point.
And consistently selling investments would eat into your returns and potentially have tax consequences (on the gains you had achieved). You wouldn’t see the growth you desired if you were always pulling money out to pay for emergencies.
A fully funded emergency fund is designed to move you forward with investing without interruption. With that in place you can consistently allocate more dollars towards investing without fearing you’ll need them for a life emergency.
The One Caveat: You foresee no immediate large expenditures
While I would not say you could never invest with large expenditures looming on the horizon, I’d seriously consider curtailing large deposits of money into investments if you think the money would be needed in the next six months. The simple reason being that the market can quickly fluctuate to the downside leaving you with less money to withdrawal than what you put in.
So if you are a teen and college is on the horizon don’t invest a lot. If you anticipate a major medical need within a year then you’d be better served to beef up that emergency savings fund. If you think you’ll be buying your first house then it’s best to save for your down payment…and all the extras (#repairs) that immediately seem to come with home ownership.
A Linear Approach to Investing Money
The approach I’ve outlined is definitely linear. It requires one to check off steps before investments can be made for retirement or the kid’s college fund. I like it that way. It keeps me focused instead of trying to play all angles.
By delaying until these milestones are reached I know I’m being affected by the time factor in the investing equation. I’m OK with that. The financial goals of paying off debt and having a fully funded emergency fund are more important than investing.
Think of it this way…those two milestones lay the foundation for the beautiful house that is to come. No one would ever consider putting on the roof (investing) before the four walls (debt payoff, savings) of the house were up.
That’s how I see investing. There will eventually come a time to build your investing portfolio but it needs to wait its turn. Then I can throw everything I can at it because my money won’t be tied up dealing with other issues.
Questions: Did you begin investing money before debt and savings were taken care of? Would you invest or pay off debt if your company offered a retirement match? Would you stop investing money for a time if you knew a major expense was around the corner?
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