The purpose of investing is straightforward: putting our money to work to potentially build our wealth. This alone is enough reason why everyone should invest our money. Most of us want to become wealthy to achieve financial freedom or prepare for future expenses. Of course, there are more specific reasons for, as well as benefits of investing.
7 Major Reasons for and Benefits of Investing
1. Potential to Beat or Outpace Inflation
Consider having $2,500 in the 1980s. This amount was the median monthly household income in California from 1985 to 1988. An average inflation rate of 3.09 percent and a cumulative price increase of 259.56 percent from 1980 to 2022 mean that this same amount had an equivalent purchasing power of about $8,988.96 today.
Moderate increases in the general and overall prices of goods and services are largely considered a sign of a well-functioning and growing economy. Inflation is arguably inevitable in most cases. However, whenever this happens, it has the potential to erode the value of our money and its spending or purchasing power.
Investing in assets and securities or other instruments that can provide a significant amount of returns is the best strategy to outpace inflation. For example, investing $2,500 in Apple in 1984 would give you a total of 19,230.775 shares. These shares are now worth more than $3.3 million—a 131900 percent increase from the initial invested amount.
2. Saving in Bank Accounts is Not Enough
Investors describe money held in banks as “sleeping funds” because they are not growing significantly. Most of the time, deposit or savings accounts earn interest rates that are lower than the inflation rate. The fact that inflation is inevitable means that the purchasing power of our money decreases over time if we save in banks.
Of course, setting aside money is important. Saving accounts have their specific purposes and advantages. For starters, similar to other money market accounts, they are the most liquid financial instrument. It is easier to withdraw cash from a bank than liquidate or sell securities such as stocks or assets such as real estate.
The rule is to save in a bank to build emergency funds sufficient enough to cover unforeseen expenses that require immediate attention or have enough spending capabilities in case of unexpected occupation loss. Banks are also ideal for short-term financial goals and objectives. You can explore other investment options once you have enough savings.
3. Taking Advantage of Compounding
Compounding is another benefit of investing. It is defined as the process in which the earnings of owned assets either from capital appreciation or interest are reinvested to purchase additional assets and generate additional earnings. Earnings from the principal investment and earnings from subsequent earnings can result in exponential earnings growth.
An example of compounding is investing in a dividend-paying stock. Suppose you invest $1000 in a publicly-traded company that sells $2.00 per stock. Your initial investment has earned you a total of 500 shares. This investment has an annual payout of around $10.00. Reinvesting these earnings will allow you to increase the number of shares you hold.
There are three critical things to make compounding work or maximize the compounding power of an existing investment: the original investment should remain intact or untouched; earnings should be reinvested; and buy-and-hold strategy or medium-term to long-term investment timeframe spanning between 8 years to 15 years, and further onwards.
4. Maximizing the Benefits of Time and Age
The best time to invest is when a particular financial market is at its lowest point. This is the general point-of-view of some of the most successful investors and traders. However, for most people, the best time to invest is always now, especially when they are young and they have time on their side. Time can be your biggest leverage.
For example, when you invest in your early 20s or 30s to prepare for your retirement, you have the potential to accumulate wealth for a smaller investment amount that will be bigger than those who invested the same amount in their late 40s and 50s. A longer timeframe maximizes the benefits of compounding and reduces the risks that come with market volatility.
It is also important to emphasize the fact that investing as early as now means allowing your money to work smarter not harder. As mentioned above, for the same amount of investible money, a younger person has the potential to earn more than someone older because of the risk-mitigating effect of time and the power of compounding.
5. Building, Growing, and Preserving Wealth
Remember that investing can potentially build and grow your wealth. This is very important if you want to prepare for big expenses in the future such as preparing for your retirement or having enough funds to send your children to reputable educational institutions. Savings in banks alone is the best way to lose the value of your money due to inflation.
However, another reason why you should invest is to preserve your wealth. Note that investing to build and grow wealth requires higher risk tolerance and a longer timeframe. Investing in stocks or in equity and index funds, as well as in other high-risk assets and securities have the potential to either grow or lose your wealth because of market volatility.
Wealth preservation, on the other hand, requires a different discipline that involves a complete revaluation and rebuilding of your investment portfolio. There are other investment options to preserve your wealth. Examples include investing in time deposits or interest-earning bonds such as corporate bonds and government bonds.
6. Importance of Achieving Financial Freedom
Financial freedom is defined as a state in which you have enough income or wealth to cover your living expenses and afford your different life goals and objectives without being dependent on employment or other active income-generating activities, as well as dependent on others. This sounds ideal but everyone should aspire to be financially free.
The reality is that most of us cannot work for the rest of our lives. Everyone will reach a certain age at which we can no longer be as productive as we once were. Some of us will be forced to retire upon reaching our retirement age while others will be burnt out from the fast-paced life and will be compelled to choose a slow-paced life.
It is also important to highlight the fact that we should treat our current occupations not just an endeavor to earn money to cover our current or immediate expenses. We should be working now and investing a portion of our earnings so that we would not be working in the future. Investing is one of the best ways for us to retire with financial freedom.
7. Contributing Further to Economic Growth
Some investors believe that investing should be an obligation of productive members of society. Everyone with the capacity should invest. This is agreeable to a certain extent. The economic significance of investing centers on the fact that it adds to the stock of capital needed to stimulate value-producing activities in the economy.
Note that channeling funds in money markets such as bank deposits help in money circulation. Investing in the stock market and corporate bonds allow business organizations to grow further and thus, create employment. Responsible participation in the derivatives market can promote the advantages of hedging and allow the creation of more capital.
Preparing for retirement and having sufficient financial safety nets can also reduce the social burden that comes from individual financial risks. For example, if everyone has enough retirement funds and health insurance coverage, there is less pressure for the society or its government to expend public funds on social welfare programs.
