When it comes to my finances, one thing I wish I had done differently is to save more earlier in my career. I did a good job paying off my debt, which is a plus, but I was so focused on debt that I waited almost ten years to start saving seriously.
There are many ways to grow your investments more quickly, such as minimizing fees and not pulling your money out of the market due to temporary drops.
However, the single biggest thing you can do to grow your investments is to invest as much as you can, as early as you can. If you’ve heard the expression “time in the market,” that is what it’s referring to.
Indeed, there is no substitute for having a long time horizon for your investments. The longer you stay invested, the more your investments are likely to grow. Adding in a few recession proof stocks to your portfolio will help with your long-term investments.
Growing Your Money with Compounding
If you aren’t familiar with compounding, it refers to earning interest on top of the interest you’ve already earned. With compound interest, the result is that your money grows exponentially rather than growing linearly.
To give a simple example, say you invest $5,000 and then simply leave it alone, but that money earns 10% interest per year.
In the first year, you would earn $500 in interest – not bad. But what happens in the second year?
Again, you aren’t touching this money at all – neither investing more nor withdrawing. Thanks to compounding interest, you don’t earn 10% on the original $5,000 – you earn it on the $5,500 you have now.
So, in the second year, your 10% return gives you $550 in interest, or an additional $50. And that money is just sitting there, requiring no effort on your part.
If you leave that money invested at 10% for 20 years, here is what the growth looks like:
By year 20, you earn $2,780 – more than half of money you initially invested!
You may also notice the line starts off relatively flat and gets increasingly steep with each year. If we let our money grow even longer, the line would only get steeper.
This is exponential growth, and as mentioned earlier, this is why investing for as long as possible is the best thing you can do for your investment portfolio.
Of course, this is just a simple example. Things in the real world are quite a bit messier, and you aren’t going to get a precise 10% every year.
If you invest most of your money in an index fund, you may get above 10% some years and below 10% other years. Some years can even be negative.
That said, indexes such as the S&P 500 generally have a positive return in the long run. Yet another reason to stay invested as long as possible.
What is the Best Way to Invest?
The truth is that there is no silver bullet when it comes to investing. Everyone has a style that works best for them. What works for me may not work for you and vice versa.
Some prefer buying individual stocks or even day trading. These strategies can yield higher returns but will also take up more of your time (especially day trading).
If you want the simplest, least involved way to save, your best bet is probably index funds. You can either opt for a mutual fund or ETF – just watch the fees. Anything above a 0.50% expense ratio is probably too high these days.
In general, day trading takes the most time and has the most risk, but has the highest potential reward. Index funds take the least amount of time to manage with the least risk, but the potential return is the lowest.
You can always combine some of these strategies, but your risk tolerance and how much time you can commit to trading will determine your overall strategy.
How to Start Saving for Retirement
Again, there are many strategies and considerations around how to save for retirement. To get started, the best first step is always to look into what your employer offers.
If your employer offers matching contributions and that doesn’t happen automatically each pay period, always be sure to at least contribute up to your employer’s match. That is free money!
Now, you may not know the best way to manage your 401(k) or other retirement account. You could always learn how to manage it yourself, but you may find that daunting – especially if personal finance is not your forte.
And there is no shame in that if it is the case. There are services out there such as Blooom that can make it easier to manage your retirement account(s).
This Blooom review helps break down the service into more detail. The basics, though are quite simple. All you have to do is tell it what allocation you want it to use for your retirement accounts – what percentage stocks and what percentage bonds.
Once that is done, the service will manage your retirement investments for you so you never have to worry about which index funds are best.
Account Types & Tax Advantages
When we think about saving for retirement, most of us are familiar with the 401(k). In reality, that is just one of many types of retirement accounts. Here are a few others:
- 403(b): similar to 401(k), but it is offered to private nonprofits and government organizations.
- 457(b): specifically offered to government employees at the state & local level. These accounts have no early withdrawal penalty.
- Individual retirement account (IRA): typically opened and funded entirely by you, the individual rather than your employer. One advantage of these accounts is you can select your own investments.
All of these accounts have tax advantages. In addition, they usually have a Roth option. With a Roth account, you pay taxes when the money is deposited rather than when it’s withdrawn. This is beneficial if you believe your tax bracket will be higher in retirement than it is now.
In either case, your money grows tax-free, which is the biggest tax advantage of retirement accounts. If your employer sponsors a 401(k) and also another type of retirement account, it is possible to have both accounts.
That means even more tax-free growth.
You may even be able to use a health savings plan (HSA) as a retirement account, but your employer must offer a high-deductible health plan (HDHP) for that to be a possibility.
With an HSA, you can put money in and withdraw it later, all entirely tax-free.
And putting all this money into tax-advantaged accounts is great because it reduces your taxable income. The lower your taxable income, the lower your tax brackets – and, thus, the less you pay in taxes on the money that is taxed.
It’s Never Too Early to Start Saving
No matter what strategy you take when it comes to saving for retirement, the single most important measure is to start investing as early as possible. If you are still early in your career and you haven’t started investing yet, don’t wait a day longer. Look at the potential dividend growth rate the longer you have your portfolio, that will tell you a lot.
That isn’t an exaggeration: start today if possible, or tomorrow if not. One of my favorite investing quotes goes something like this:
“The best time to invest is 20 years ago. The second best time is today.”
Bob Haegele is a personal finance writer, blogger, and dog walker. He enjoys growing his wealth through investing and helping others do the same.