Why investing is important
Many of my colleagues have a vague sense that they should do something with their money. Even among the frugal, however, saving money seems more common than investing money. Many people are comfortable with saving money but are apprehensive about investing it.
To be fair, living below your means and saving money is financially responsible. But do not underestimate just how important investing is.
In my musings about whether medicine was a financially lucrative profession, I discussed an alternative scenario if I took the job offer I had out of college in 2007. To quickly recap, the job was $68,000 per year. If I pinched my pennies and invested $15,000 per year in VTSAX, as of November 2020 that portfolio would be worth over $550,000. This was assuming no raises, promotions, or bonuses, and not considering any employer 401k matching.
If I had simply saved $15,000 per year in a bank account, after 13 years of saving I would have saved around $195,000, because the interest rate on traditional bank accounts is almost negligible. The opportunity cost of not investing is over $350,000! The invested portfolio is 2.8x the size of the saved portfolio.
In fact, 13 years is not a very long time in the world of investing. Thanks to the power of compound growth, the longer one stays invested, the larger this gap grows. Additionally, inflation erodes the value of money over time at around 2 to 3 percent per year. Without investing, money saved becomes less valuable over time. The compound annual growth rate, or CAGR, of the US stock market has been between 9 to 10% per year.
To illustrate the difference over 30 years, which is a typical working career, let’s look at the difference between investing $10,000 per year into an S&P 500 index fund from 1990 to 2020 versus saving $10,000 per year without growth. Keep in mind that during this time period, two major market downturns occurred with the dot-com bubble in 2000 and the global financial crisis in 2008 (and a more transient COVID-related downturn in 2020). The invested portfolio is worth about $1,786,000 as of November 2020, assuming monthly contributions of $833. After accounting for inflation, this is about $865,000 in 1990 dollars. The saved portfolio, however, is only worth $300,000 today, which is only about $145,000 in 1990 dollars. Either way, the invested portfolio is almost 6x the size of the saved portfolio.
Therefore, for people with a long time horizon, the opportunity cost of not investing is huge. The real risk is not from short-term market volatility, but rather from sitting on cash on the sidelines.
Happy investing!
