We receive reader mail at Betterment, and we came across this simple question that has a not-so-simple answer.
For such a widespread concept, investing is widely misunderstood—and often miscast. While we all know the high-stakes side of the financial world (see “Wall Street,” the movie), investing for most people is about long-term financial growth and security. Now, that common-sense approach is gaining even more traction as a new generation of companies (like Betterment) are engineering more efficient ways for more people to enjoy the gains the market can offer.
When you sock away money in a savings account, you’re watching your money grow—largely thanks to how much and how often you save (i.e. you’re not getting a big boost from accumulating interest, because interest rates on most savings accounts are less than 1%).
When you invest, however, you’re buying securities (stocks, bonds, mutual funds, and other products) that enable you to put your money into certain markets and gain a return or profit based on the performance of those securities. That can help your money to grow more rapidly than it would in a savings account. If you were to buy, say, Lego stock for $100, and it gained 10%, you’d have $110—a $10 ROI (return on investment).
But let’s say you bought $100 worth of shares of a stock mutual fund (i.e. basket of stocks from many companies), that was primarily invested in businesses overseas. If those stocks lost 10% on average, you’d have $90. A certain amount of risk is the price you pay for being in the market.
Your risk tolerance is pretty much what it sounds like: it's how much risk you’re willing to take on, given possible returns. You can minimize some risk by diversifying your portfolio. So you wouldn’t invest only in an overseas mutual fund; you’d include one from the U.S., and a bond mutual fund, and so forth. Never put all your eggs in one stock, bond or mutual fund basket; a variety of assets can even out gains and losses in different sectors, making your returns are steadier.
Plus, the reality is—despite the famous stock market crash in the 1980s, the tech bubble bursting in 2000-01, the recession that began in 2008—investing in the market for the long haul (10, 20 years or more) will typically help to grow your money, despite the risk involved. If you invested $100 every month in a well-diversified portfolio that gave you a 5% return, on average, each year, it would grow to about $148,856.50 over 40 years. If you kept that money in a checking account, earning 0% interest in most cases, you’d end up with about $40,000.
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Jon Stein is the founder and CEO of Betterment.