A lot of younger people tend to be shortsighted when it comes to money. I know I was, and I'm sure many older people would say the same. Yet younger people who can keep the long term in mind have a leg up when it comes to achieving financial stability and freedom.
As members of Gen Z (people born between 1997 and 2013, according to the U.S. Census) grow to working age and get into a position to begin investing, it's important to understand that they have one of the greatest investing tools on their side: time.
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The key to building wealth in the stock market
There is an old Chinese proverb that says: "The best time to plant a tree was 20 years ago. The second best time is now." The same can be said of investing. The earlier someone begins investing, the better, thanks to a phenomenon called compound earnings.
Compound earnings are when the money you make on investments starts to earn money on itself. It's your interest earning interest. To see compound earnings in action, imagine investing $1,000 one time and receiving 10% annual returns on that investment. Here's how it would work in this scenario:
| Year | Beginning Investment | Interest Earned | Ending Value |
|---|---|---|---|
| 1 | $1,000 | $100 | $1,100 |
| 2 | $1,100 | $110 | $1,210 |
| 3 | $1,210 | $121 | $1,331 |
| 4 | $1,331 | $133.10 | $1,464.10 |
| 5 | $1,464.10 | $146.41 | $1,610.51 |
Calculations by author.
If you were to withdraw the $100 you earned after each year, you'd continue to earn only $100 every year on your initial $1,000 investment. Yet by leaving your earnings invested and allowing them to accrue interest, the amount you earn increases exponentially with each passing year.
Removing your $100 earned each year would result in $500 earned after five years. With compound earnings, however, you'd earn $610.51 over that same span.
Time continues to be an important factor
To maximize the benefits of compound earnings, you need time. As a younger investor, the amount of time on your side shouldn't be taken for granted because it can be a major key in wealth generation.
For example, averaging 8% annual returns, here's approximately how investments would stack up for someone investing $250 monthly over various time periods.
| Years Invested | Personally Invested | Investment Value |
|---|---|---|
| 5 | $15,000 | $17,600 |
| 15 | $45,000 | $81,400 |
| 25 | $75,000 | $219,300 |
| 35 | $105,000 | $516,900 |
| 45 | $135,000 | $1.159 million |
Calculations by author using Investor.gov interest calculator. Investment value rounded to the nearest hundred.
Notice that there's a $30,000 difference in personal investments between each 10-year gap, yet the difference in investment value noticeably changes the more time that elapses.
From five to 15 years is roughly a $63,800 difference in investment value, 15 to 25 years is roughly a $144,300 difference, 25 to 35 years is roughly a $297,600 difference, and so forth.
It's all about remaining consistent
Gen Z workers may not have the same amount of money to invest as those in older generations, but the time on their side can make up a lot of ground.
Suppose a 25-year-old invests $250 monthly until age 60 and a 35-year-old invests $500 monthly until 60, both averaging 8% annual returns. By 60, the person who started at 25 would have around $516,000. The person who started at 35 would only have around $438,000, even though they invested double the amount each month.
Building a solid portfolio doesn't take huge chunks of money; it just takes time and consistency.
Remaining consistent in investing is often easier said than done, but one way to help yourself is by incorporating dollar-cost averaging. When you dollar-cost average, you put yourself on a set investing schedule and stick to it no matter what.
If you get paid biweekly, for instance, you could decide to invest $125 every time you receive a paycheck. It doesn't matter if stock prices are up, down, or stagnant, your job is to invest the $125 regardless. Sometimes you'll invest when stock prices are overvalued; sometimes you'll invest when they're undervalued. What matters most is that you stick to your schedule.
I can't stress enough how powerful time can be in investing. Your future self will surely be glad you took advantage of it.
