Why You Should Start Investing

Hello!

Welcome to our first lesson about the stock market! Before we go over the technical details of what it is and how to get started, it is important to know WHY we should be investing in the first place. Hopefully, having this information upfront will motivate you to continue to take this course seriously and make it a priority, even on those tired nights when you just want to watch Tv or your favorite streamer on YouTube.

Should I Start Investing?

The question about whether or not to start investing is a straightforward one, in my opinion. Yes, you should! If you do your due diligence (aka research) before investing your money in MOST cases, the benefits will outweigh the risks. If you only put money into a savings account, you are actually LOSING money.

That is because of something called inflation. Inflation simply means one dollar buys less today than it did yesterday. This is also referred to as purchasing power.

If you have ever talked to an elderly person, you have probably heard the “movies were a nickel back in my day” speech. This is a perfect example of inflation. Now you need over 200 nickels just to buy your movie ticket!


This can also be seen in the graph below, which shows the price of a loaf of bread over the last 70 years.

Rising Cost of Bread

In the United States, the US Bureau of Labor Statistics (BLS) monitors the inflation rate. They calculate it by using something called the Consumer Price Index (CPI).

  • According to the BLS, the CPI is “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
  • Put simply, the average price of common goods (bread, milk, shelter, gas, medical bills, etc.) is added together and then compared with the previous year’s prices. The percentage difference between the two numbers is the rate of Inflation.

Simplified Inflation Example

Experts aim to have a yearly inflation rate of 2%, which is considered “healthy.”  The annual inflation rate is currently at 5.4%, at the time of this writing (2021), for All items.

  • All Items indicates Food & Energy Goods (oil, natural gas, electricity) have been included in the calculation.
  • Whereas, All Items Less Food and Energy indicates Food and Energy Goods have been removed from the calculation.

Food and Energy are seen as more “volatile,” meaning their price moves up or down much more frequently. Some experts believe removing them from the calculation provides a more stable and realistic number.

Why it Matters

The current rate of inflation is MUCH greater than current interest rates. Interest is the amount of money a bank will pay you for storing your money with them or the amount you will pay if you borrow the money instead of the one lending it (think of a car loan or mortgage).

FDIC Monthly Rate Cap Information as of September 20, 2021

An interest rate of 0.06% is extremely low. Historically the United States interest rates have been very low since the financial crisis of 2008.

Without going too much into its economics, the federal government will cut interest rates during a financial downturn. This makes it cheaper to borrow money, and in theory, businesses will be more willing to borrow and invest in their companies, which fuels the economy.

Saving your money in a traditional savings account is one of the safest routes. You do not have to worry about fluctuations in the Stock Market or losing your money in a house fire. Your account decreases only if you remove money via a withdrawal or the bank goes out of business. Nowadays, if a bank does go under, the FDIC will cover your losses up to $250,000.

  • This wasn’t always the case. Before the FDIC existed (1933), Bank Runs were common. A Bank Run is exactly what it sounds like; people would run to the bank to try and withdraw their money before the bank ran out and went out of business. An image of one can be seen below.
The crowd outside of the East New York Savings Bank during the run on that bank, November 24, 1933 (Photo: Bettman/Bettman/Getty Images)

Bank Runs were one of the many factors that led to the Great Depression in the 1930s. There were even instances where a bank run would happen because of false rumors that the bank was going out of business. This led to people running to the bank to get their cash, which ultimately put the bank out of business and turned the rumor into a self-fulling prophecy.

How This Affects You

The important point here is that you are losing money if inflation is more than the interest rate. While the actual dollar amount in your account may be increasing, from the interest payments, your money is buying less than it used to.

The table below illustrates how inflation affects your bank account and your purchasing power. However, the example is very simplified for educational purposes and reflects one period, month, quarter, or year; however, you would prefer to think of it

Inflation Rate of 2% Example
  • The bank deposits the interest payment into your bank account at the closing of the period (month, quarter, or year). To determine how much to pay you, it multiplies your account balance by the current interest rate. The equation looks as follows:

Note: AB = Account Balance

AB with Interest = (Initial AB* Interest Rate) + Initial AB

AB with Interest = ($1,000*0.06%) + $1,000

AB with Interest =$0.60 + $1,000

AB with Interest = $1,000.60

  • During that same period, inflation has occurred. We know that inflation means you will be paying more for goods, but we can more easily illustrate its effects by adjusting your bank account balance.

AB Adjusted for Inflation = (AB with Interest) – (Ab with interest*Inflation Rate)

AB Adjusted for Inflation = $1,000.60 – ($1,000.60*2%)

AB Adjusted for Inflation = $1,000.60 – $20.01

AB Adjusted for Inflation = $980.59

Notice how at the end of the period you have LESS money than when you started? In this example, if you had $1,000 to start the period, you would lose about $20 due to inflation at the end of the period. And that is AFTER the bank paid you for storing your money with them. If you had 1 million dollars sitting in the bank, you would lose almost $20,000!

Keep in mind this is a modest 2% inflation rate. Let’s see how that same table looks using the current rate of 5.4%.  

Inflation Rate of 5.4% Example

If you had $10,000 in the bank, you would lose over $500 with this inflation rate!  

The Invisible Tax

Inflation is often referred to as the “Invisible Tax.” This is because, unlike taxes, we tend not to notice how inflation affects our bills. Unless inflation increases quickly, and our bills increase rapidly.

Money Chimp has a useful inflation calculator that shows what inflation rates have been for previous years.

Countering Inflation with Investing

The benefits of investing are that your Return on Investment (ROI) generally outpaces the average annual inflation rate. On average, the market produces 10% returns per SoFi. This is a year-over-year historical average.

  • This means your investments will increase in value in some years and decrease in others. But overall, if you leave your money in for the long term (decades), you expect an average gain of 10% per year.

Adjusting for inflation, the average yearly ROI is positive even with a high inflation rate of 5.4%. By investing, we can counteract our money from inflation and increase our wealth. A historical chart of the S&P 500 can be seen below.

S&P 500 Growth Since 1900

Investing as early as possible is critical; it gives you more time to ride out the years the market goes down. There are downsides to investing.  

  • The market is NOT guaranteed to produce 10% yearly returns; that is only a historical average.
  • Your money is not as easily accessible or liquid as in a checking/savings account.

Money invested through an investing account requires you to sell your positions before you are able to access the actual cash. If the market is doing poorly, but you need the money ASAP, you will have to sell for a loss and are unable to ride out the poor market.

Important Takeaway

The previously mentioned situation illustrates why it is imperative to have a separate emergency fund, either a checking or savings account that you can easily withdraw money from.  

The amount to have saved depends on your financial situation, but it is generally recommended to have at least 6 months’ worth of expenses. Doing this allows you to leave your money in the investment account for the long term and reap the rewards.  

Your Best Friend: Compound Interest

Another reason it is a good idea to start investing as early as possible is because of something Compounding Interest. According to CNBC, 69% of American adults don’t know what compounding interest is.  

Don’t worry if you are one of these people. That is exactly why we created this lesson, and we will teach you right now!  

Compounding interest means you earn interest on your initial investment + any interest already earned from previous periods. Here is a simple example to illustrate.  

Floyd invests $1,000 into the stock market and does not touch it for multiple years; the table below shows his returns from utilizing Compounding Interest.  

Note: For simplicity, we assume the return rate is 8% each year 

Account Growth from Compound Interest

At the end of year one, his account has grown from $1,000 to $1,080. At the end of year two, it has grown to $1,166.40. Let’s look at where these numbers are coming from.

Year 1 Ending Balance = Starting Balance + (Starting Balance*Return %)

Year 1 Ending Balance = $1,000 + ($1,000 x .08)

Year 1 Ending Balance = $1,080

Year 2 Ending Balance = Starting Balance + (Starting Balance*Return %)

Year 2 Ending Balance = $1,080 + ($1,080 x .08)

Year 2 Ending Balance = $1,166.40

It is important to note how the earnings are calculated by using that year’s starting balance. Now, let us take a look at John. He decides instead to place his $1,000 into a savings account that only accrues simple interest. He also does not touch it for multiple years. The table below shows his returns.

Note: For simplicity, we assume the return rate is 8% each year 

Account Growth from Simple Interest

At the end of year one, his account has grown from $1,000 to $1,080. At the end of year two, it has grown to only $1,160.00, which is less than Floyd’s. Notice how John’s earnings column is the same dollar amount each year, no matter the starting balance? Let’s explore why.

Year 1 Ending Balance = Starting Balance + (Starting Balance*Return %)

Year 1 Ending Balance = $1,000 + ($1,000 x .08)

Year 1 Ending Balance = $1,080

Year 2 Ending Balance = Starting Balance + (Initial Deposit*Return %)

Year 2 Ending Balance = $1,080 + ($1,000 x .08)

Year 2 Ending Balance = $1,160.00

With simple interest, the earnings are calculated by multiplying the return/interest rate by the INITIAL deposit. You do not earn interest on previously earned interest.

Important Takeaway

Because of compounding interest, your money can grow exponentially. That is why you can contribute $200,000 of your own money to your retirement account, but your account can be over $1,000,000 at retirement age.  US News has a great graph illustrating this point.

When to Start Investing

I invest AND have a savings account. This allows me to have access to cash for an emergency, and I can leave my investments in the stock market.  Whether you decide to Invest, Save, or both is up to you, but the most important takeaway from this lesson is that you should start as early as possible!

The YouTube channel “The Plain Bagel” has a great video explaining some of these previously mentioned concepts. Click on the video below to watch it. We do not take any credit for their work or claim the video to be ours. Please like, follow, and share their video to support their channel!

Extra Resources

Don’t forget to check out the Materials Tab for helpful extra resources and definitions of Key Terms!

Our Partners

Below are some of our partners to help you start your investing or saving journey. By using our unique referral links, you become eligible to receive FREE stocks or sign-up bonuses!

In some instances, we may receive a small commission. You do not have to use our links, but we appreciate anyone who supports us by doing so! We will only ever recommend products/services that we are using ourselves or that we truly believe in.

Start Your Investing or Trading Journey Today!

If you would like to start investing or trading today, below are some of our favorite brokers. Many offer FREE stocks or sign up bonuses if you use our referral link to sign up!

Our Favorite Brokers for New Investors:

Webull: Use this link to potentially receive FREE stocks!

Robinhood: Use this link to potentially receive FREE stocks!

J.P. Morgan Chase Wealth Management (Great if you already bank with Chase):

Our Favorite Legacy Brokers for Retirement/Investing:

TD Ameritrade: Online Stock Trading, Investing, Brokerage | TD Ameritrade

E*TRADE: Investing, Trading and Retirement – E*TRADE Financial (etrade.com)

Fidelity: Fidelity Investments – Retirement Plans, Investing, Brokerage, Wealth Management, Financial Planning and Advice, Online Trading.

Charles Schwab: Charles Schwab | A modern approach to investing & retirement

Vanguard: Vanguard: Helping you reach your investing goals | Vanguard

Our Favorite Brokers for Mutual Funds:

TD Ameritrade: Online Stock Trading, Investing, Brokerage | TD Ameritrade

E*TRADE: Investing, Trading and Retirement – E*TRADE Financial (etrade.com)

Fidelity: Fidelity Investments – Retirement Plans, Investing, Brokerage, Wealth Management, Financial Planning and Advice, Online Trading.

Charles Schwab: Charles Schwab | A modern approach to investing & retirement

Vanguard: Vanguard: Helping you reach your investing goals | Vanguard

Our Favorite Brokers for Automatic (robo) Investing:

M1 Finance: Use this link to potentially receive a sign-up bonus!

Acorns: Use this link to potentially receive a sign-up bonus!

Our Favorite Brokers for Day Trading:

TD Ameritrade: Online Stock Trading, Investing, Brokerage | TD Ameritrade

Interactive Brokers: https://ibkr.com/referral/nathan166

Our Favorite FREE Trading Platforms for Day Trading:

TD Ameritrade’s thinkorswim (TOS) (Need TD Ameritrade Account First):

Interactive Broker’s Trader Workstation (TWS):

Our Favorite Paid Trading Platforms for Day Trading:

Das Trader (Need to connect it to your Interactive Brokers or TD Ameritrade broker account)

Our Favorite Brokers for Crypto Investing:

Coinbase: Receive $10 for funding your account!

Webull: Use this link to potentially receive FREE stocks!

Robinhood: Use this link to potentially receive FREE stocks!

Our Favorite Crypto Trading Platform:

Coinbase Pro (Need Coinbase Account):

Our Favorite Brokers for Mobile Investing (Phone or Tablet)

Webull: Use this link to potentially receive FREE stocks!

M1 Finance: Use this link to potentially receive a sign-up bonus!

Acorns: Use this link to potentially receive a sign-up bonus!

Robinhood: Use this link to potentially receive FREE stocks!

J.P. Morgan Chase Wealth Management: https://accounts.chase.com/investing/share/1809071739

TD Ameritrade: Online Stock Trading, Investing, Brokerage | TD Ameritrade

E*TRADE: Investing, Trading and Retirement – E*TRADE Financial (etrade.com)

Fidelity: Fidelity Investments – Retirement Plans, Investing, Brokerage, Wealth Management, Financial Planning and Advice, Online Trading.

Extra Resources:

Key Terms (Courtesy of Investopedia):

  1. Bank Run – “A bank run occurs when a large number of customers of a bank or other financial institution withdraw their deposits simultaneously over concerns of the bank's solvency. As more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the withdrawals.”
  2. Bureau of Labor Statistics (BLS) – “The Bureau of Labor Statistics (BLS) is a federal agency that collects and disseminates various data about the U.S. economy and labor market. Its reports include the Consumer Price Index (CPI) and the Producer Price Index (PPI), both of which are considered to be important measures of inflation.”
  3. Compounding Interest – “Compound interest (or compounding interest) is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods.”
  4. Consumer Price Index (CPI) – “The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.”
  5. Federal Deposit Insurance Corporation (FDIC) – “The Federal Deposit Insurance Corporation (FDIC) is an independent federal agency insuring deposits in U.S. banks and thrifts in the event of bank failures. The FDIC was created in 1933 to maintain public confidence and encourage stability in the financial system through the promotion of sound banking practices. As of 2020, the FDIC insures deposits up to $250,000 per depositor as long as the institution is a member firm.”
  6. Inflation – “Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed a percentage, means that a unit of currency effectively buys less than it did in prior periods.”
  7. Interest (APR) – “Interest is the monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate (APR).”
  8. Investing – “Investing is the act of allocating resources, usually money, with the expectation of generating an income or profit.”
  9. Purchasing Power – “Purchasing power is the value of a currency expressed in terms of the number of goods or services that one unit of money can buy. Purchasing power is important because, all else being equal, inflation decreases the number of goods or services you would be able to purchase.”
  10. Return on Investment – “Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI tries to directly measure the amount of return on a particular investment relative to the investment’s cost. To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment. The result is expressed as a percentage or a ratio.”
    • Return on Investment (ROI) Definition (investopedia.com)
    • Simpler Definition – ROI, put in layman’s terms, is just how much profit you make from a certain transaction. Did you make more than it cost to do it? Then you have a profit and a positive ROI. Did you make less money than it cost? Then you did not have any profit, actually lost money and that is a negative a ROI.
  11. Savings Account – “A savings account is an interest-bearing deposit account held at a bank or other financial institution.”
  12. Simple Interest – “Simple interest is a quick and easy method of calculating the interest charge on a loan. Simple interest is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments.”
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