Investing is the 5th step of 7 in a do it yourself financial plan. Most people don’t understand that to build wealth you have to invest. A combination of saving and investing is important to your successful do it yourself financial plan. By doing both, you automatically lower your risk, increase your potential return and save on taxes.
Many people are frustrated by the fact that they can never get ahead just by saving their money. They are correct. Everyone should invest and not keep all of their money in cash and cash equivalents for these 2 reasons:
1. Taxes. Every dollar earned or every dividend distribution you receive is taxed at some tax rate. If your cash is not getting enough return to replace the loss from taxation, then you are not making money but losing it. Every dollar that you own must replace the loss from taxation in order to grow.
2. Inflation. The CPI (Consumer Price Index) gives us an overall idea of how much goods and services go up every year. For instance, if you put $1.00 in your piggybank in 1980, it would have had to increase to $2.66 (or 5.58% average annual return) in 2008 to be able to buy the same amount of goods and services that it could in 1980. You can find the current inflation rate at the Bureau of Labor Statistics website.
Inflation and taxes are very scary to those on a fixed income. People can get the illusion that they are taking very little risk as they receive a known amount each month. The reality is that they are receiving a guaranteed loss since each year it will purchase a lesser amount of goods and services. This is why everyone needs some funds that are invested for growth. We need the opportunity to keep up with taxes and inflation even if loss of principal is a potential or else we are assured of a loss. Having a mix of some money in a safe account and some invested for long term growth can help investors feel comfortable with risk while being able to keep up with taxes and inflation.