Having a savings account isn’t enough
Saving money is important, but it’s only part of the story. Smart savers start by building sufficient emergency savings within a savings account or through investment in a money market account. But after building 3 to 6 months of easy-to-access savings, investing in the financial markets offers many potential advantages.
Why investing matters
Investing is an effective way to put your money to work and potentially build wealth. Smart investing may allow your money to outpace inflation and increase in value.
The greater growth potential of investing is primarily due to the power of compounding and the risk-return tradeoff.
The power of compounding
Compounding occurs when an investment generates earnings or dividends, which are then reinvested. These earnings or dividends then generate their own earnings. So, in other words, compounding is when your investments generate earnings from previous earnings.
If you invest in a dividend-paying stock, for example, you might consider taking advantage of the potential power of compounding by choosing to reinvest the dividends.
The risk-return tradeoff
Different investments offer varying levels of potential return and market risk.
- Risk is an investment’s chance of producing a lower-than-expected return or even losing value.
- Return is the amount of money you earn on the assets you’ve invested, or the investment’s overall increase in value.
Investing in stocks, for example, has the potential to provide higher returns. In contrast, investing in a money market or a savings account likely won’t offer the same return potential, but is considered less risky than investing in stocks.
The amount of risk you carry depends on your appetite — or tolerance — for risk. Only you can decide how much risk you’re willing to take for the potential of higher returns. But if you’re seeking to outpace inflation, taking on some risk may be necessary. An increase in risk may provide more potential for your money to grow.
To maximize the benefits of compound interest, start investing as soon as possible and automatically reinvest your dividends and other distributions. Read about the power of compounding and the cost of waiting.
Know your investing style
Understanding the type of investor you are is a key step toward understanding what sort of investment approach is best for you. What’s your investing style?
Learn the basic investing types
When it comes to investing, you have many options. Before deciding which investment vehicles are suitable for you, it’ll help if you know what they are, how they work, and why they may be a good fit for your needs.