If you’re in your 20s or 30s, this article is aimed squarely at you. If you’re older, I want you to give it to a young person. You’ll be doing them a huge favor.
Investors in their 20s have a golden opportunity to start out right. Doing so can literally be worth millions of dollars.
(Disclosure: I don’t know your parents. But I know thousands of adult investors, and I’m very confident of this: If you take my advice in the following seven steps, you’ll be more successful than the vast majority of investors in your parents’ generation.)
1. Save Money vs. Spend It
I know, I know: This sounds like boring advice from an old guy who’s forgotten what it’s like to not have much money.
So let me say it this way: If you are old enough to be reading this, you’re old enough to know that there are consequences from the things you do — and from things you don’t do.
You can’t be a good investor unless you are an investor to start with. And (duh) you can’t be an investor unless you have money to invest. That means saving.
Yes, that’s too obvious to even be worth writing (or reading). But you’d be amazed at how many people in your parents’ generation just can’t get their heads around this notion. Don’t be like them.
As soon as you have an income, regularly start saving some of it for your future. Even if you can’t afford to put away more than 1% or 2% of your income, do it. Get in the habit of saving and start experiencing the satisfaction of seeing that you have some money growing for your future.
Here’s a guarantee: If you regularly save some money and put it away for the future, you will never be sorry. Here’s another guarantee: If you don’t save some of your money for the future, someday you will wish that you had. I promise.
2. Save Now; Don’t Wait Until Later
Every dollar you save now will be worth a lot more than a dollar you save later. I mean a LOT more. A few simple numbers will prove it.
Imagine you have $100 to save and that you can invest that at a 10% compound rate until you’re 65. Invest that $100 when you’re 25, and it will grow to be worth $4,526. That’s $45.26 for every dollar you save.
If you wait until you’re 40 and you think you “can afford it,” your $100 will grow to only $10.83 for every dollar you save. Wait until you’re 50? Forget it: $4.18.
Your parents probably waited too long and didn’t take good advantage of time. Don’t follow in their footsteps.
3. Save More Instead of Less
Get in the habit of saving at least 10% of your income — 15% is much better if you can do it. If you make it a habit and do it automatically, you’ll be able to live OK on the remaining 85% to 90% of your income.
And you’ll never regret it later.
Your parents’ generation hasn’t learned this lesson. The median household savings for people age 56 to 61 is less than $20,000.
Your extra savings, and the extra gains you are likely to achieve, can double or triple the amount of money you have in retirement.
4. Invest in Stock Funds, Not Bond Funds
Sure, bond funds are less volatile than stock funds, but over the years, stocks have produced vastly better long-term returns.
Over the past 89 years, the U.S. stock market has appreciated at a rate of about 10% a year. Government bonds have appreciated at only 3.5% to 6%.
If you invest $1,000 for 40 years, a 10% return (stocks) could leave you with $45,259, vs. only $10,286 at a 6% return for bonds.
5. Own Many Stocks Instead of Only a Few
In the 1990s, your parents and their friends may have invested heavily in Microsoft
But it didn’t. Microsoft stock peaked in 2000, then plunged along with the rest of the market. It took more than 16 years to regain that former peak value.
This is one of thousands of possible examples of how stock picking goes dreadfully wrong. In fact, most of the gains in the stock market come from only 4% of the companies.
Millionaires invest in hundreds, even thousands, of companies; poor people invest in only a few. An awful lot of people in your parents’ generation do the latter.
You can do better: With index funds and ETFs, you can easily and inexpensively invest like a millionaire. Do it.
6. Don’t Pay Taxes When You Don’t Have To
Millions of people in your parents’ generation neglected this point, but you can do better.
As soon as you start earning income that you have to report on a tax form, you are eligible to put money aside in an IRA. Think of it as your own private pension. Money you invest there isn’t taxed until you take it out — and if you use a Roth IRA, your earnings will never be taxed at all.
You can set aside up to $5,500 a year in an IRA, and you should do it. In addition, sign up for any 401(k) or similar retirement plan that’s available to you. This insures that you’ll automatically save money (Lesson #1), that you’ll save now (Lesson #2), and that you’ll have the opportunity to invest in many stocks (Lessons #4 and #5). That’s a financial home run.
7. Keep Your Expenses Low
All mutual funds charge for expenses. But some charge much more than others.
In many parts of life, you tend to get what you pay for. But in this case, exactly the opposite is true.
What I’m about to say is pretty basic fifth grade math, but you would be surprised how many people in your parents’ generation don’t seem to comprehend it: Every extra dollar you spend on expenses is a dollar that you earned but will never benefit from.
You can get excellent stock funds (notably index funds) that charge expenses of 0.3% or less. Yet millions of people in your parents’ generation pay three or four times that much for funds that usually don’t do better.
If you cut your expenses by 1% a year, your return goes up accordingly. Over a lifetime, that seemingly small change can be worth millions of dollars when you retire.
If you pay attention to this detail, along with the other items I’ve listed, you’ll be well along the road to being more successful than your parents.
For an easy way to expand your investment knowledge, check out my free video: 50 Facts Every Investor Should Know.
Richard Buck contributed to this article.
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