Investing can be intimidating at first. There are countless products to choose from, and many people lack formal financial education. Nevertheless, it's never been more important to save and invest. So, let's examine a straightforward way to get started and see why the decision to invest is so critical.
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Why bother investing?
The best reason to invest becomes clear when you examine the alternative: What would happen to your savings if you never invested?
Let's take the average American, who typically works around 40 years and spends about 20 years in retirement. Most people will want to save some of the income produced during their working years to supplement their retirement income -- whether it comes from social security payments, a pension, or some other source.
However, this is where things get tricky, because the money that is earned during a person's working years isn't the same as the money in retirement. Why? Very simple -- inflation. In short, inflation is a financial fact of life -- and it stinks. For example, here's a chart that shows the value of one dollar over the last 50 years.
US Consumer Price Index: Purchasing Power Of the Consumer Dollar data by YCharts.
As you can see, a single dollar has lost 85% of its purchasing power over the last five decades. In everyday terms, the prices of ordinary items -- groceries, gas, homes -- have skyrocketed over the last 50 years. It's something everyone intuitively understands. It's why a gallon of gasoline used to sell for 50 cents (or less) in the 1970s, and it now sells for over $3 per gallon. What's more, we've all experienced the effects of rapid inflation over the last few years when prices rose at their fastest pace in decades.
At any rate, inflation -- fast or slow -- means that people who fail to earn a return on their savings will see their wealth decrease over time. To compensate for it -- let alone make headway -- there's only one thing to do: Invest.
How to Invest
Now, to be clear, there are many ways to generate a return on your money, including real estate, precious metals, commodities, and even cryptocurrencies. But let's focus on stock investing -- and if there's one product that is perfect for beginners, it has to be exchange-traded funds (ETFs).
In short, ETFs are like mutual funds, but they trade like stocks. That makes them accessible, cheap, and omnipresent. There are literally thousands of ETFs to choose from, but for a novice investor, there are only a few I'd recommend. My top choice? The Vanguard S&P 500 ETF (VOO -1.04%).
What's so great about this ETF is that it combines simplicity, value, and performance. The fund tracks the benchmark S&P 500 index. It's a basket of 500 American stocks -- including Apple, Microsoft, Nvidia, and many others -- that is widely cited by media organizations as a proxy for the stock market.
When a person buys shares of the Vanguard S&P 500 ETF, they are, in effect, "investing in the stock market." The returns on their investment will closely match the returns generated by the S&P 500.
That's important because, over the last 50 years, the S&P 500 has generated a compound annual growth rate (CAGR) of 10.6% -- more than enough to offset the effects of inflation (roughly 3.7% per year).
To recap, everyone deals with inflation, and there's no way to avoid it. However, by investing savings into an index-tracking ETF, such as the Vanguard fund noted above, anyone can go beyond simply counteracting the effects of inflation -- they can build wealth.
