When you’re consistently earning more than you’re spending, it’s time to seriously consider investing. If you have some money sitting in your bank account that’s not your emergency fund and you don’t need it a couple of years down the line either, you know you’ve reached the wealth accumulation stage, and it’s time to invest.
I think you’ll agree that your money is only as valuable as its ability to purchase goods and services. Due to inflation and rising costs, that ability decreases over time. Money sitting in the bank depreciates in value and $100 this year will be worth only $98 next year(assuming a 2% inflation rate). The somewhat-evil forces of inflation are slowly chipping away at your hard-earned cash and you need to do something about it!
The 4% rule dictates when you can theoretically stop working. When you have collected 25 times your annual expenditures in savings and investments, you can live off your savings by withdrawing 4% a year forever after. At this point, you are financially independent(FI). Check out Vanguard’s Retirement Nest Egg calculator or do your own math as follows:
But should you be okay with inflation? To answer that question, let me introduce you to the 4% rule.
- Monthly Expenses: How much do you spend in a month?
- Annual Expenses: Multiply that by 12.
- Multiple that by 25.
Example – If I spend $700 every month, my financial independence number is $700 * 12 *25 = $210,000. When I have saved $210,000, I can cover my annual expenses without working for an income. I could withdraw 4% of the FI number (In this example, 4% of $210,000 happens to be $8400/year or $700/month) every year there on.
You may need to play with your FI number because this calculation does not take into account how your lifestyle and expenditures will change over time or the unanticipated needs that will need to be met. It also doesn’t take into account other goals you may be saving for. However, it does give you a realistic idea of what your future requirements might be and it’s a good starting point.
By now you may realize that only saving hard cash is not enough. Even if you have a bank account, the negligible rate of return makes it equivalent to cash. If you want to make your money grow, it’s time to consider investing.
Investing can be simple and doesn’t require much beyond basic math. You can start by investing a $100 or even less. The longer you keep your surplus funds in the market, the longer they will have to compound. Einstein even called compound interest the 8th wonder of the world!
Of the many options out there, stocks and bonds are the most accessible asset classes for the lay investor. Stocks are tiny pieces of companies that you could buy on the stock market and these transactions happen online. As companies make profits, you get to partake in the profits! You can make money off stocks in two ways – firstly, by allowing the stock price to appreciate over time before selling and, secondly, by receiving dividends. Over time, this will allow you to accomplish your financial goals.
Looking at the trajectory of an important stock index(aka “the market”) in the graph below, the Dow has only increased in value over the last 100 years! Go to this link and check out how the market rose over 10-20 year increments and you will see that your investments will increase over time too!
Hopefully this article has given you a sense of why investing is so important for everyone. That being said, there is no rush! Take the time to get very familiar with your spending patterns, build your emergency fund and then educate yourself on this life skill.
Mallika Sen is an engineer in the Bay area. She loves to read, watch Netflix and plan things – but not simultaneously. She has a lot of “micro-hobbies”, which is a term she’s made up to describe her habit of intensely researching or practicing a new topic or activity for a few months or more at a time before moving on to the next. She believes this adds perspective and excitement to life and would love to share what she learns along the way here at LiveYourDream.org.