In the time I've spent as a financial advisor working to help our members secure their personal finances, “When is a good time to start investing?” is one of my all-time favorite questions.
As with most personal finance topics, the answer depends on your financial situation. But for many people, the short answer is now. Time is on your side.
Read on for four reasons why it may make sense for you to start investing sooner rather than later.
Reason 1: There's a time value of money.
Reason 2: Get the most out of your money with compounding.
Reason 3: Your financial house is in order.
Reason 4: You have access to retirement accounts.
Reason 1: There's a time value of money.
We hear this phrase tossed around a lot. It means that money in the present is worth more than money in the future. Why? Because inflation causes money to lose its purchasing power.
To illustrate the time value of money, let's take a little field trip back to 1952. To set the scene, the first Chevy Corvette prototype was just completed and the first Mr. Potato Head flew off the shelf.
That year, if I were to buy one gallon of milk and five gallons of gas, it would have cost $1.96. Compare that to today, where the same purchases would run me about $18.97.
Why is time value of money important?
As we see from this example, prices tend to increase over time. One dollar 30 years from now won't buy as much as one dollar today.
We all instinctively understand that. That's why we invest. Our goal is to earn a return that outpaces inflation, so that our money doesn't lose its purchasing power over time.
There's another reason why a dollar today is worth more than a dollar in the future: It has earning potential. With successful investing, we all hope to turn $1 into $2, and then $3, $4, etc. If I have $10,000 today, my goal is to use that to earn a return that outpaces inflation, so that my money is worth more than $10,000 20 years from now.
How do we accomplish that? Through the power of compounding.
Reason 2: Get the most out of your money with compounding.
When we invest our money, we hope that our money will earn more money, and that money will earn money, and so on and so forth. Our gains come not only from our initial principal, but also from our earnings.
Let's look at an example to understand how compounding works. Sally and Anna both invest $10,000 into a hypothetical investment that earns 6% yearly. Sally decides to spend whatever she makes each year, while Anna allows her earnings to remain invested, giving it a chance to grow even more.
At the end of 40 years, how much do Anna and Sally have, respectively?
Since Sally spent all she gained, she only has $10,000. Anna, on the other hand, has $102,857. That includes her initial investment of $10,000, plus a whopping $92,857 in growth. When it comes to compounding, patience pays off. The graph below shows that Anna's growth really takes off in later years.
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Reason 3: Your financial house is in order.
It's important to have the foundation of your financial house in order before jumping into the stock market and thereby taking on risk. How do you know if your financial house is in order? Chances are good that you have a financial footing if you have an emergency fund, you're spending less than you earn and you're conquering high-interest credit card debt. Here's what I mean.
You have an emergency fund.
This is critical. Without an emergency fund, you might be tempted — or forced — to remove what you just contributed to your investments to pay for an emergency. Depending on the type of account, you could incur taxes, penalties, or both, and possibly even lose money depending on stock market conditions.
How much emergency fund should you have? Before starting to invest, set aside $1,000 in an emergency fund. Then continue to save until you have enough money to cover three to six months of essential living expenses. This way, when an emergency arises, you have funds set aside specifically to help cover those expenses.
You're spending less than you earn.
You should only invest if your budget allows for it. If you have extra money at the end of the month, then you're following one of USAA's core advice principles: Spend less than you earn. Great job.
On the other hand, if you're not spending less than you earn, then chances are good that you're constantly going into debt or eating into an already-existing savings cushion. Before you start to invest, look at your budget and make some adjustments, so that you're controlling your expenses.
Need help? Read How to create a budget: Lessons from being broke.
You have high-interest credit card debt under control.
People often wonder if they should pay off debt first or start investing first. Comparing the typical interest rate on a credit card versus the return of the stock market gives us good information to guide our decision.
For the 20-year period ending Dec. 31, 2019, the S&P 500 averaged 6.06% yearly return. Compare this to a credit card interest rate, which can be 16% or higher, and it seems it may be more beneficial to redirect some of your monthly savings to make above-minimum and additional payments to pay off high-interest debt quickly.
But don't feel that all your debt must be erased before you start investing. It just needs to be under control. With the right plan, you can simultaneously invest and pay down debt. For example, you can take advantage of matching contributions provided through an employer retirement, which leads us to the next reason.
Reason 4: You have access to retirement accounts.
Employer-provided retirement accounts are a great opportunity to start investing.
This is a fairly simple way to get started, and your employer may even offer matching contributions. When companies offer a matching contribution to their employer-provided retirement account - think 401(k), 403(b) and Thrift Savings Plans - they're offering a valuable employee benefit. It's free money, and we don't like to pass up free money.
Even those without access to an employer-provided plan can probably save for retirement with either a Roth or traditional individual retirement account. Learn the difference between the two with our Quick Guide: Roth Versus Traditional IRA.
It doesn't take a lot of money to start investing. Starting with $25 or $50 is better than not starting at all. If you're ready to begin investing but aren't sure how, check out this article on the basics of investing.
It's never too early to start investing.
Learn more about investing and explore options to find what works best for you.