It’s important in this day and age to understand why investing is a smart financial decision for the longterm. This is especially true for index funds. Simply put, they are a culmination of earnings of all the top-performing companies in corporate America (if you set your portfolio to more equity-based) – which you have a small piece of. Here’s why you should consider index funds investing:
Consistent Annual Returns
It has been proven over the span of decades that index funds investing consistently generate a 10% average annual return rate. ETF (exchange traded fund) distributors like Vanguard have historically backed this claim for future earnings. This means you can rest assured that the deposits you make every month will always amount to a firm profit by the end of the year.
Keep in mind that the more you deposit, the more of an annual return you’ll make. If you were to make an initial lump sum deposit of $2,000 and make monthly contributions of $300, after 12 months (on a 10% annual return rate) you will have made at least $379 from that annual amount of $3600. Making a larger deposit and larger monthly contributions than this will obviously yield more of a return.
Compound Interest Grows Your Money
With index funds, you need to be a patient person to be able to see satisfactory returns. It works best over the longterm as a result of compound interest. In contrast to simple interest, compound interest accumulates by adding the principal interest rate plus any interested accrued. It’s basically interest added to your interest. So as years pass on, the amount earned will exponentially get bigger with this system. In the example above, by year two you would have made $1,175 dollars after factoring in compound interest. And think of how this differs from a savings account. Typically savings accounts have a smaller 2-3% interest rate on deposits, so the alternative will produce more of a return in the long-term.
I’ve been using Wealthsimple Invest for my index funds investing as they make it easy for Canadians to understand this concept. There is no initial minimum deposit requirement (you can start with $0 to open an account) and you can even set automatic deposits at weekly, monthly, or annual frequencies. So no need to remind yourself to make that monthly deposit – it can already be taken care of for you. See here to sign up.
Teaches Financial Discipline
In a consumerist society it’s very easy to fall victim to bad spending habits. Especially when you’re young. But if you start index funds investing in your late teens to early twenties with the goal of gaining long-term wealth, you are teaching yourself to forgo short-term gratification. This quality is essential for all areas of life, and will serve you well as you’re developing personal finance habits. I do believe that making multiple streams of income is beneficial in the short and long term, but what is equally important is ensuring a secure future for both yourself and potential kids and grandkids.
Peace of Mind
As mentioned, multiple streams of income is helpful and actually necessary in today’s world. However, this process takes time and dedication, so along the way you may only be operating on a salary to pay bills. And panic could set in if you were to unexpectedly lose that job, reverting you to your savings account to get by until you get back on track. But what if your savings account only stretches you so far and you haven’t found a job or another way to generate income? Luckily, your index portfolio can assist you in this situation. I am not, by any means, encouraging you to withdraw your money early as this will take you further from your long-term goal. But in a do or die situation, you can rest assured that these funds can keep you afloat – even if it’s for a few months.