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Investing in Stocks

Why is Investing Important

Investing in Stocks for Beginners - picture of a road sign with green background and large white capital letters say financial freedom why investing is important for the future

As the years go by most adults will end up purchasing a house or some other accommodation to live in and for a lot of adults this will be their only asset of significant value. It's an asset that generally appreciates in value over the years - so it's worth more and more as time goes on. However the family home is not considered an investment as it's not able to provide a future income.

Most adults spend their lives working - either for an employee or running their own business and most adults will try to enjoy life outside of work. For some this may involve eating out regularly while for others it may involve a leisurely sport like playing tennis or skiing. Whilst these recreational pastimes involve an expense - this is not an issue whilst they are still working. In other words the adult can afford to finance their chosen lifestyle.

But as humans, people have not evolved to the stage were they can continue to work as they age past a certain point - at some point they will either not be capable to work or younger people will be seen as being more desirable for an employer and replace the aging worker.

Now this creates an issue - if the adult stops working then they stop receiving their income which was used to finance their lifestyle. This means the adult can no longer finance their lifestyle

Sure there will be some token pension benefits but this will generally only be a fraction of the income they received whilst working.

So is there anything the aging worker can do to continue financing their lifestyle after they retire form work.

The answer is YES - it is to put some money aside regularly whilst they are working. A small amount of money regularly put away adds up to a considerable amount of money over the years. This is further compounded when invested.

Let's look at some figures to illustrate this:

Investing for the Future

Someone working puts away $1000 per month.

1. Investing in bonds earning around 2.5% p.a. amounts to a little over $300,000 in twenty-years time.

2. Investing in stocks earning around 10% p.a. including dividends amounts to around $750,000 in twenty-years time.

As can be seen from the above figures, money put away regularly over time adds up to a nice nest egg in the future. This is money that can help finance your lifestyle when you retire in the future.

Capital Increase

The total amount of money invested in the above example is $240,000 over twenty years.

1. Bonds. The capital increase is $60,000 for the investment in bonds at 2.5%.

2. Stocks. The capital increase is $510,000 for the investment in stocks at 10%.

Yes Stocks generally return more than Bonds but they are also considerably more volatile. This means that the year to year returns fluctuate considerably with some years giving negative returns. As a general rule stocks are best held over the long-term.

Future Income

1. Bonds. They will provide an income in the future at the future rate (currently 2.5%). On $300,000 the annual income received amounts to $7,500.

2. Stocks. Large-cap stocks also provide an income in the form of a dividend at around 2% which gives an annual income of $15,000 in twenty years time.

A twenty-year investment period means that the person starts investing whilst they are 45-years old assuming they retire when 65-years old.

Starting to invest earlier, say at 35-years, means the investment period increases to thirty years. This has a profound effect on the investment value when retiring

30-year Investment Period

1. Bonds. At 2.5 they will be worth $540,000 with an annual income in 30-years of $13,500 with the total amount invested being $360,000.

2. Stocks. At 10% Large-cap stocks will be worth $2.2 million with an annual dividend income in 30-years of $44,000 with the total amount invested being $360,000.

While not everyone can start investing while they are in their thirties or younger, as the above figures illustrate the younger you start then the much more the retirement investment nest egg will be worth.

Summary

The main purpose of investing is to provide future wealth - this enables you to hopefully maintain your lifestyle - or at least provide a significantly better lifestyle than what a pension on its own could provide when you retire.

After thirty years investing a total of $360,000 in stocks actually gave a massive increase of $1,840,000 to give a total worth around $2.2 million. As a bonus there's an annual income from dividends of $44,000.

Investing generates future wealth through the principle of compounding interest. There are two factors that affect the returns.

Two factors that affect the returns

1. The higher the annual percentage return then the more the investment will be worth in the future.

2. The longer the investment period then the more the investment will be worth in the future.

Stock returns are usually higher than the returns from Bonds which provides a larger best egg, but stocks are considerably more volatile than bonds - especially in short to medium-term.

Therefore it's best to take a long-term view with stocks and to accept that there will be some really bad years with negative returns. The trick to investing in stocks over the long-term is not to panic and sell when returns are bad. In other words, don't take a short-term view with a long-term investment.

For those investors who find the short-term volatility of stocks to much to bear, a popular strategy is to combine stocks with bonds in the one portfolio. There is a tendency for bond values to move in opposite direction to stock values, thereby one helps to offset the other which lowers the volatility but also lowers the long-term returns.

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