Investing is a bit like exercise — everyone knows it’s good to do but they don’t always get round to doing it as much as they should.
The difference is that, while pushups and runs should help you get fitter, investing helps you grow your wealth.
This may seem like a self-evidently good thing but it’s worth outlining a couple of other benefits that you get along the way.
Investing can help you beat inflation
Putting money into a savings account isn’t a bad thing.
But having money in a savings account for a long period of time can mean you lose money.
That’s because, over time, currencies tend to lose value. We call this process inflation.
Take the British pound.
£1 in 1950 would be worth about £35 in 2020. Or, to put it another way, £1 today is worth 1/35th of what it was in 1950.
That’s inflation in a nutshell.
Why is that bad?
Leaving money in a savings account is bad if the inflation rate is larger than the interest rate on that account.
Say you had £100 in a savings account with 2% interest per year but inflation was 3%.
You would end the year with £102 but, because of inflation, that would be worth less than the £100 you started with!
Investing money is no guarantee that you’ll beat inflation but it is one potential way around it.
By putting your money into stocks or ETFs that may increase in value more than the rate of inflation does, you take on some risk so that you can prevent your cash from losing its value.
You can compound your wealth by investing
It’s always a good thing to take action to grow your personal wealth.
What’s even better is using the money you have made to increase the amount by which your wealth increases.
This is known as compounding. In simple terms, it means that the money you have made already will help you earn more money in the future.
To take an example, let’s say you manage to get a 5 per cent annual return on a £10,000 investment. Assuming you keep your gains invested here’s what you’d make over the years.
In this same example, we’d start in year zero with £10,000 and it would grow in value by 5 per cent to £10,500 over the course of a year — a £500 increase.
But if the investment increased by 5 per cent again the following year, the value would increase by 5 per cent of £10,500 — £525 — which is more than it did in the first year.
As time goes by, the amount by which your wealth increases in value grows, even if the rate at which it grows remains constant.
You can create a source of passive income
Passive income is a term that’s used a lot by finance geeks.
In simple terms, passive income is money that you make without having to do much in the way of work. If you own a flat and rent it out, for example, that could be classed as passive income.
There are two major ways that investing can let you make money via passive income.
- You buy a share at a low price and sell it at a higher one.
- You buy shares in companies that make payments, called dividends, to shareholders.
In order to make money from investing, you do need to keep track of your investments and make decisions as to what to buy and sell and when to do it.
Still, once you’ve grasped a few basics and know what you want to invest in and achieve financially, this shouldn’t be too tricky. And the result may be that you see yourself with another source of wealth that you can use to retire, go on holiday or keep for an emergency.