If you’re a “Just Starting” investor, congratulations! Recognize that few investors use their time and patience to grow capital assets. If you plan to retire decades from now, it may feel like there’s plenty of time to take care of an amorphous future.
This distant time, let’s say 40 or more years away, is difficult for most of us to imagine or fathom. However, without resources to supplement your retirement income many years from now, it may be challenging or impossible to live the life to which you’ve become accustomed.
For that reason, taking care of your future self must begin now.
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Portfolio Diversification
Regular and disciplined investments in a diversified portfolio may yield positive and long-term returns. Simply stated, true diversification spreads portfolio risk.
One of the top reasons younger people don’t begin to invest early in life is that they’re unaware of key financial concepts, e.g. the time value of money or the benefits of compounding.
Time Value of Money (TVM)
The time value of money concept says that money in your account now is worth more than the same amount of money in a future date.
That’s because your money has earnings potential between today and any point in the future. For this reason, TVM is also called present discounted value.
TVM recognizes the following concepts:
• Money grows only by the process of investing it. If the holder of money delays investment, this is the loss of opportunity or opportunity cost.
• TVM considers the possible investment return over a period of time.
• Compounding periods, e.g. in a savings account, are also considered in calculating TVM.
TVM is one of the best ways to understand why it’s essential to start investing as early as possible. The sooner you start to invest, the more time your money has to grow:
• Time in the investment markets is your benefactor. Time in the market, not market timing, is important to your investment success.
• Diversify your portfolio by selecting a variety of financial products, e.g. equity and bond funds, to reduce portfolio risk.
• Consider the cost of investing by selecting low-fee fund vehicles.
Benefits of Compounding
Compounding describes the process by which an investment’s earnings (from interest payments, dividends, or capital gains) are reinvested to create greater earnings growth over time.
Capital growth occurs as the investment continues to generate new earnings from the principal invested as well as the earnings accumulated from these prior periods.
Compounding is like interest on interest. Over time, the effect of compounding magnifies returns. This is one of the reasons financial authors refer to the process as the miracle of compounding.
Albert Einstein enthusiastically called compounding the eighth wonder of the world.
We all know how much of a genius Einstein was about pretty much anything. If you are an early investor, make sure to listen to him and start to benefit from compounding today.
Financial institutions and banks credit compound interest over a daily, monthly, or yearly compounding period.
Invest Early
If you work for an employer, participate as soon as possible in their 401(k) retirement plan.
If the company doesn’t have a 401(k) plan for its employees, open an Individual Retirement Account (IRA – whether it’s a traditional or a self-directed IRA) and put aside a certain amount of your monthly income to contribute to it.
Regular monthly contributions plus the convenience of a 401(k) or IRA account will automate the process of saving and investing.
Note that your savings will grow faster because they’re not currently subject to current taxes. As long as you don’t withdraw money from your retirement plan, your money is sheltered from federal, state, and (if applicable) local taxes.
Risk Allocation for Just Starting Investors
Most Just Starting investors are less likely to have additional financial burdens or obligations, e.g. a mortgage loan, spouse, or children.
Because you’re not limited by these obligations, it’s possible to allocate some of your investments to higher-risk vehicles.
In turn, these higher-risk investments can yield higher portfolio returns.
If you begin the practice of investing money early in life, you typically have a longer time horizon in which to invest before retirement.
Let’s assume it’s possible for you to save $200 a month at age 25. If your investments return seven percent per year, your portfolio will grow to approximately $525,000 at age 65.
In comparison, if you start to save $200 a month at age 65, and you earn the same seven percent annual return, your portfolio will reach approximately $244,000 by your 65th birthday.
Current tax advantages may be available if you start investment later in life. For instance, your 401(k) or IRA plan may allow you to make catch-up contributions if you’re 50+ years old.
Why You Must Diversify
Choose investments across a variety of market categories. If your long-term investment goal is to achieve growth and income, choose conservative companies with long-term growth potential that pay regular dividends.
Reduce portfolio risk by choosing fewer high-growth opportunities and invest in hard asset like physical gold through a gold IRA.
Who knows what will be worth an ounce of gold when you will be 65? See our guide on choosing the best gold IRA company for more information.
Investment quality debt, e.g. corporate or government bonds, are also good long-term investments. Keep in mind that trading bonds before maturity can result in a profit or loss to your portfolio.
Disciplined, Regular Investing
Make investing a regular habit. If you lose a job, avoid taking money from your investments. This creates a taxable event in the short term and reduces the amount of capital you’re investing in for the future.
Once you find a new job, continue to pay your portfolio each and every month to achieve the best long-term results.
Rebalancing Your Portfolio
One of the benefits of investing early in life is that you may have been the ability to assume higher risk and better returns from higher growth assets like equity funds.
When the portfolio asset allocation changes, e.g. when fluctuations in the market change the percentage of assets allocated to each portfolio category, it’s important to rebalance your portfolio.
This means that your financial stake in each portfolio category is adjusted to reflect the initial percentage of capital contributed to it.
Taxes and Investing
If you’re investing in a tax-deferred retirement account, e.g. an IRA or 401(k) plan provided by your employer, your money grows faster than one that’s subject to tax considerations.
Avoid taking money from a tax-deferred account until you retire. At that point, you must pay taxes on the money distributed from the tax-deferred account.
Keep in mind that Roth IRA plans can also help you to accumulate tax-free savings for retirement. You fund the Roth IRA with after-tax funds but pay no taxes on the money when it’s withdrawn.
Check your modified adjusted gross income to learn if you meet limits established by IRS:
• Earnings are exempted from federal taxes if the Roth IRA was in place for a minimum of five years.
• You must be older than 59-1/2 years old at the time you make a withdrawal from the Roth IRA, or
• If you’re less than 59-1/2 years old and the Roth IRA is in place for five years, funds may be withdrawn if you’re disabled (or by heirs if you die) or you’re acquiring a first home.
Just Starting Investors
Save regularly and in a disciplined way in your tax-deferred IRA, employer 401(k), or Roth IRA. Your disciplined portfolio management is necessary to build a retirement nest egg.
Unlike a portfolio that’s subject to current tax liabilities, all dividends and profits can provide extra money for your future. Keep in mind:
• Manage costs, e.g. commission fees or management costs, associated with your investment portfolio.
• Time value of money: the sooner you invest, the better your potential results in the future.
• Learn more about investing in the years ahead. Mega trends change, interest rates rise and fall, and new companies bring their products and services to market.
Start Early to Retire Rich
Invest early to reach important financial goals, e.g. retiring, acquiring property, or starting a business. Because invested capital may grow in value over time, it’s generally true that time in the market is an important ingredient of your investment success.
Quality Counts
Acquire quality assets:
(1) Identify securities with outstanding characteristics based on management credibility and balance sheet stability.
(2) Consider elements like market positioning, i.e. what distinguishes a company or fund from its peers, or global trends that support its future growth potential.
(3) Learn about the financial strength of the entity, including capital reserves or sales profitability, cash flow, earnings, and more.
(4) Evaluate the entity’s corporate management and governance structure.
(5) Assess the valuation of the security to determine its quality, e.g. discounted cash flow or price/ earnings (P/E) ratio relative to the industry group and average market.
Long-Term Strategy
In addition, time can help to offset some of the risks associated with investing. The value of your investment portfolio is likely to rise and fall over the years and it is possible to lose money when investing.
However, an investor with time to hold an investment over the long term is likely to recover the loss.
Change in Laws, Products, and Terms
Recognize that laws, financial products, and terms relating to investing can change. It’s important to learn more about investing throughout your lifetime.
Types of Risk
Realize that most investments, including some savings products, involve the acceptance of risk. Types of risk include :
(1) Liquidity risk, or how easily you can get your funds on demand;
(2) Time risk, or how quickly your money can grow;
(3) Capital risk, or whether it’s possible to lose part, all, or more than your original investment;
(4) Other risks, including inflation, taxation, market conditions, or external factors, may directly or indirectly affect your investment value.
Time Is Money
Many young adults put off making all investment decisions. They may argue that it’s best to wait until their lives become more financially stable.
Younger investors have time on their side. If an investor commits $10,000 to an investment at age 20, the magic of compounding grows the investment to more than $70,000 at age 60 (assuming a five percent interest rate).
Assuming the same interest rate, if the investor commits $10,000 at age 30, the investment grows to $43,000 at age 60. At age 40, investing $10,000 yields $26,000.
The Bottom Line
Start now. Tech-savvy Just Starting investors have the time to learn more from their investment successes and failures.
They have more time to study the financial markets and refocus their investment strategies. They build confidence in the ability to make investment decisions.
For many investors, starting earlier makes it easier to build wealth. Investing as early as possible is one of the best decisions you can make in life. Start wherever you are now. Invest regularly in small amounts until you can save more.
It’s never too late to get started, if you’re over 40 years old, go to our investment strategy for established earner.