How Much of Your First Savings Should You Save and Invest to Achieve Wealth?

Many individuals start their journey to financial independence by setting aside a portion of their earnings as savings. However, the truly significant wealth growth comes from investing those savings effectively. This article delves into the importance of savings, investments, and the right strategy to achieve wealth, especially for first-time savers.

Start Early and Invest Wisely

The earlier you start saving and investing, the better your chances of achieving wealth, but simply saving is not enough. According to financial experts, you need to invest to truly advance your financial position. A regular bank account is useful for day-to-day transactions, but it is insufficient for growing your wealth. To truly get ahead, you need to invest your savings in a manner that allows your money to work for you, even in the face of inflation.

For example, consider owning a bank stock instead of keeping your money in a savings account. The dividend yield on many bank stocks can be significantly higher than the interest rate offered by savings accounts. Banks like Peoples United Financial (NASDAQ: PBCT) offer a dividend of 4.8%, whereas the current APY (Annual Percentage Yield) on savings is as low as 0.01% (as of November 2021).

In many cases, investing in stocks, particularly dividend-paying stocks, is a more viable option. However, it is essential to diversify your portfolio to minimize risk and maximize returns.

Consider the Full Picture

Some argue that you should save 100% of your first savings, but this is often seen as a circular question. Instead, the logical next step is to add to your savings with subsequent earnings. It is recommended to invest in a low-fee, diversified portfolio weighted towards equities. This approach allows you to take advantage of stock market growth while keeping costs low.

Alternatively, many individuals ask about the percentage of their gross income they should save and invest. A general rule of thumb is to aim for at least 15% of your gross income. Some would even suggest saving more, as any percent above this is beneficial too. It's crucial to include any contributions made by your employer in retirement savings, such as 401(k) plans. For instance, if your employer matches 50% of your first six percent of salary deferral (adding up to 3%), then you would need to save at least 12% (15% - 3%).

Remember, the exact percentage can vary based on your specific financial goals and timeline. Understanding your financial timeline and expected returns will help you make more informed decisions.

Example of Wealth Accumulation

Let's consider an example to illustrate the power of compounding. If you save and invest $2 per day, you can accumulate significant wealth over time. The returns from the stock market can vary, but over a long period, they can provide substantial growth. For instance, if you were to achieve an average return rate of 7% annually (as many equities have historically), the compound interest effect would be remarkable.

To demonstrate, let's assume you invest $2 per day over 40 years. Here’s the estimated growth:

$2 per day $730 per year
Note: This is a simplified estimate. Real-world figures may vary based on actual returns, inflation, and other factors. 40 years of investment @ 7% return Approximately $836,551
Note: This estimate is based on annual contributions compounded at 7%.

These figures highlight the importance of regular, consistent investing over an extended period.

Conclusion

The key to achieving wealth is not just saving but also investing wisely. Early start, consistent contributions, and a well-diversified portfolio are crucial components of financial success. Always aim to save and invest a significant portion of your income, and consider the specific financial advice tailored to your individual circumstances.

Remember, the journey to wealth is a marathon, not a sprint. Stay patient, stay disciplined, and stay informed.