When I started my career in finance, my mother, without hesitation, said, "Now you're going to know all of the secrets about finance and investing." I feel this is how most conceptualize the world of finance—the idea that a certain population knows how the system works and capitalizes off if it. Those that don't, suffer.
This misconception needs to change and there's only one way to do that: Knowledge and education. Add consistency of your approach and patience, and you'll understand how your money could work for—and against—you.
There's no get-rich-quick scheme. When it comes to your finances, you can only control two things:
1. How much you spend.
2. How much you save and invest.
Compound interest, simply speaking, is interest on interest. The dollars you invested made money in 2020. You're not just making money on your initial investment in 2021; you're making money on your investment, plus the interest during 2020. Every year, that interest on top of previous years' interest grows to a larger sum. Be patient with this: It can take 10 to 20 years to see significant growth!
Alternatively, interest on interest on a loan payment makes that car or TV you bought far more expensive, the longer you stretch out payments. It's important to control your debt or pay it off as fast as possible. Yes, you need a car—and possibly a house. Besides those large items, only purchase what you can afford.
Where Can I Get Interest or a Rate of Return for my Investment?
When you have a 401(k) or another investment vehicle, you're investing in the market. On a high level, the market is where you buy and sell stocks—which are small slices of a large company. When you buy stocks or are invested in the market, you're actually a minority owner of a publicly traded company. These companies go public in order to raise capital to grow. You in turn, as an investor, reap the benefits of the growth of these companies. If the company grows and returns profit, the price of each stock will increase as the company continues to perform.
You could also buy treasuries of the U.S. government, certificates of deposit or bonds from companies. You're actually buying their debt—and you are the bank this time! They pay you back the interest on the loan you give them.
Additional Pointers and Best Practices
- Talk to your kids about savings and debt! Break out online calculators that show compound interest. Demonstrate how quickly credit cards can get out of control and how much they earn if they're smart with their money.
- Educate yourself. Go online and read savings and investing best practices. Then read some more!
- Only buy what you can afford. If you don't have the money to pay off the balance quickly, don't buy.
- When using a credit card, pay it off every month! This goes back to only buying what you can afford. Again, interest on interest.
- Make a budget understanding your cash flows. Know what you can spend!
- Diversify and invest in mutual funds or exchange traded funds to get started.
- Be consistent with savings. Put away 10 – 15% of your income in your 401(k) or other investment vehicle, to pay your future self. This will help set you up in the right direction for retirement. We can't all afford to put in 10% of our salary; will we not be ready for retirement? There are ways to catch up. With 1 – 3% cost-of-living raises each year, move your 401(k) contribution up 1% each year from your raise. After four or five years, you should be at the 10% threshold and in a better spot. If you're starting this in your 40s, your aim should be closer to 15%!
Ultimately, keep it simple when it comes to saving and investing. If it's too complicated, it's usually too good to be true. There's no instant success. Follow saving and spending best practices, be consistent and intentional, and—above all—be patient!
Chris Gervat is a Financial Advisor at Lifeworks Advisors, a multigenerational team that provides wealth management services and strategic advising to successful families, businesses, and entrepreneurs. Learn more at lifeworksadvisors.com.
This article originally appeared in the Dec 2020/Jan 2021 issue of West Michigan Woman.