Why You Should Start Investing Like a Real Adult With Erin Lowry
Erin Lowry is the author of Broke Millennial, Broke Millennial Takes On Investing and Broke Millennial Talks Money: Scripts, Stories, and Advice to Navigate Awkward Financial Conversations.
Her first book was named by MarketWatch as one of the best money books of 2017 and by Business Insider as one of the best personal finance books for 2020. Erin’s style is often described as refreshing and conversational. She’s appeared on CBS Sunday Morning, CNBC and The Rachael Ray Show. Erin is a columnist for Bloomberg Opinion and has written for The New York Times, Cosmopolitan Magazine, and USA Today. She's spoken at Fortune 500 companies, SXSW and universities around the country. Erin lives in New York City with her husband and their rambunctious dog.
To learn more about Erin visit her website and follow her on IG @brokemillennialblog where she share money tips and insights.
Erin Lowery wants to remove the shame and embarrassment around debt and financial struggles prevents people from seeking the help they need and shake the misconcpetion that investing is only for the wealthy. Her Broke Millennial Book Series are tools to do just that. Level up your money!
The following is an excerpt from Broke Millennial Takes on Investing: A Beginner’s Guide to Leveling Up Your Money that Erin has generously shared with our community.
Why You Should Start Investing Like a Real Adult
The simplest reason is this: it’s an efficient way to build wealth.
Seasoned investors, personal finance writers, financial advisors, and pretty much anyone doling out money advice will wax poetic on the advantages of starting young and being consistent as an investor. The reason for this isn’t wishful thinking about what could’ve been if they’d only started sooner or been a little more aggressive with their contributions to the stock market. It’s simple math.
Reason 1: Compound Interest
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it,” Albert Einstein, allegedly, once remarked.
Regardless of which wise man (or woman) made the statement, truer words were never spoken. Compound interest and the principle of compounding are essential reasons why investing early and consistently are touted as the means of wealth creation.
In short, compound interest is earning interest on interest. In extremely simple terms, it works something like this:
On January 1, 2019, you invest $1,000 in an index fund. (We’ll get to what that is shortly.) By December 31, 2019, you’ve earned an 8 percent rate of return, so a total of $1,080 is now in your account. Starting in 2020, you begin earning interest on the $1,080 in your account, not just on the initial $1,000 investment. In 2020, you earn a 6 percent return on your $1,080, so you now have $1,144.80 in your index fund. Year after year, your money compounds, and you earn interest on your interest.
An increase of $144.80 in two years might sound like chump change, but imagine how quickly you can take advantage of compounding if you’re contributing to your investments monthly or even annually? In the scenario just described, you didn’t put in another penny after the initial $1,000 investment and you still earned $144.80 in two years.
Or try this example:
Instead of starting with $1,000, you begin investing $100 per month in an index fund. Over the course of twenty years, with the fund receiving an average 7 percent return, you will have earned $49,194.59. It only would’ve amounted to about $24,000 if you’d put the same $100 in a basic savings account each month instead of investing it.
Investing allows you to take advantage of compound interest in a way that socking your money away in a savings account doesn’t.
Reason 2: Inflation
“The idea is, you will not outperform inflation without investing,” says Carrie Schwab-Pomerantz, president of the Charles Schwab Foundation, and senior vice president at Charles Schwab & Co. Inc. “What I mean by inflation is the natural rise of prices for goods.”
A hundred dollars can’t buy you as much today as it could’ve in 1989 or 1999 or even last year. Before you feel like contradicting me, let me say that obviously this isn’t always true for every good on the market. Thanks to competition in certain sectors and advancements in both manufacturing and technology, there are items once inaccessible to the general masses that are affordable today. But when we’re talking about inflation, it’s really referring to purchasing power. It’s why your grandparents could take a family of four out to a nice dinner for five dollars in the 1950s, but you can’t buy a value meal at McDonald’s for one person for five dollars. Having $100 in your bank account in 1989 would be equivalent to having $203.591 today, according to the Consumer Price Index Inflation Calculator from the United States Department of Labor.
Money nerds make a big deal about inflation because your money will essentially lose value over time if it isn’t at least keeping pace with inflation. From January 2008 to January 2017, 2 percent represented a decent rule of thumb for what to expect inflation to be.
Your money needs to keep up with inflation, especially when you’re saving for long-term goals like retirement. Just putting that money in a savings account will erode your purchasing power because savings accounts don’t offer great interest rates. Or, as it’s more commonly called, annual percentage yield (APY). In 2019, many bank accounts only offer you a measly 0.01 percent APY. That means if you have $1,000 in savings, you’ll get a whopping $0.10 in interest by the end of the year. Some banks offer higher rates, like 1.75 percent APY, which would net you $17.50 in interest, but that’s still a pretty measly rate if that’s where you’re putting your entire life savings because you aren’t investing.
Investing helps protect your money against inflation. Sure, there will be years of low returns, but the average annualized return of the stock market will (most likely, because I can’t make promises about market performance) outperform inflation. We know this because we have decades and decades of data, and even factoring in terrible years, it still averages out to beat inflation. However, this argument does make the assumption that your investments are diversified over a variety of sectors and companies and not all in a single stock.
Reason 3: Time
The earlier you start, the longer you have to let compound interest do its job for you, and the better you can weather the ups and downs of the market. And best of all, the less money you have to invest each year in order to meet your goal. Think that sounds suspicious?
Meet Jake and Stacey, twenty-six-year-olds who would like to retire at age sixty-two. They’ve just started new jobs, and neither one has ever invested or saved for retirement before. They each earn $50,000 a year, and their employer offers a 4 percent match on their 401(k)s.
Stacey enrolls right away, putting 4 percent of her salary ($2,000) in her 401(k) in order to get her full employer match (an additional $2,000). For simplicity’s sake, let’s say Stacey stays at the exact same salary for the next thirty-six years, and that she receives an average 7 percent return on her investments.
In thirty-six years, when Stacey is sixty-two, she’ll have just shy of $600,000 in her 401(k).
Jake decides to wait until he’s thirty-six to begin investing in his 401(k). That means ten years of employer matches left behind, which, before compound interest, is $20,000! Again, for simplicity’s sake, we’ll say Jake also stayed at a stagnant $50,000 salary per year his whole career.
Jake tries to play catch-up and puts 10 percent of his $50,000 salary toward his 401(k). That’s $5,000 a year from Jake + the $2,000 employer match he receives. He, too, receives an average 7 percent return on his investments.
In twenty-six years, when Jake is sixty-two and wants to retire, he’ll have almost $481,000 *1 in his 401(k).
Jake contributed $3,000 more per year to his 401(k) than Stacey did, yet he accrued approximately $119,000 less than Stacey because she started earlier.
The Jake and Stacey example highlights why time matters. The earlier you start, the less you have to invest each month or year in order to reach your goals. Trying to play catch-up later is much harder than most people think.
“What you forget when you’re a young person is that you don’t have a mortgage yet, you don’t have a family yet. Your financial commitments are less, and you have flexibility, and making decisions may feel tough then, but it’s easier to make [them] then than when you have a mortgage and a family,” explains Julie Virta, senior financial advisor with Vanguard Personal Advisor Services®.
Even if you earn a lot more later in life, it doesn’t always mean you’ll have hundreds to thousands of spare dollars a month to try and catch up on the investing you should’ve done a decade ago.
*1 The compound interest calculations performed in this book are done using my favorite online calculator, from the US Securities and Exchange Commission, which you can find here: https://www.investor.gov/additional-resources/free-financial-planning-tools/compound-interest-calculator.
Reprinted from Broke Millennial Takes on Investing: A Beginner’s Guide to Leveling Up Your Money by arrangement with TarcherPerigee, an imprint of Penguin Publishing Group, a division of Penguin Random House LLC. Copyright © 2019, Erin Lowry.
