The old saying “time is money” is absolutely true when it comes to the world of investing. Time value of money has a powerful effect on investments, so those who begin investing even small amounts while they are young have a huge advantage over those who invest considerably more later in life.
This month’s blog article may be old news for the seasoned investor, but I wanted to address an issue that should be passed along to kids or even grandkids. I have three children of my own and I may have told them something 100 times, but until they hear it from someone else, it doesn’t sink in. So, I wanted to provide some insight and examples that may spur some thinking and discussions, and also address some common misconceptions. Feel free to pass this guide on how and when to start investing along to any youngster who might benefit and encourage them to start thinking long term right away.
To start, let’s review the most common misconceptions we hear from beginner investors, and even some older ones that have not learned these lessons.
- “I don’t have enough money”. While it is true that young investors can be inundated with debt from student loans, car payments or newer mortgages – many can find at least a small amount to invest on a monthly basis. Most systematic investment plans start as low as $25 a month. The list of excuses has to be pretty long to not be able to find that amount in any budget that is serious about getting started.
- “I don’t know anything about investing”. Ignorance can’t, or shouldn’t, be an excuse. Beginner investors have more resources available to them than ever before, so it comes down to desire.
- “Investing is too risky”. But it doesn’t have to be. Many young adults are keenly aware of the economic crisis and the resulting chaos. However, investing can be managed in a way that provides protection during downturns, and even the overall allocation used can offer protection.
- “Investing can wait until I’m older”. Young investors can contribute significantly less money over time than older investors in order to reach their goals. I’ll give some examples below but every year procrastinated away will result in more needing to be invested to achieve similar outcomes.
- “Investing is for old people or Wall Street types”. While the media can portray many investors as very wise or power hungry types, most investors are ordinary people trying to reach goals, whatever those might be. It is true that you’re never too old to start investing, but it is also true that you’re never too young.
- “My 401k should be all I need”. Depending on just social security or just your 401k can be risky. It is difficult to predict what will happen with social security and simply counting on an employer sponsored retirement plan has not always worked out.
Overcoming all of these objectives can be easy if you are determined to make a significant difference over the long haul. Some easy steps to take are 1) preparing a budget, 2) Open a savings account first to establish an emergency fund of roughly three to six months of living expenses, 3) once the emergency fund is established, divert those funds to investments that give you an opportunity for greater return over time.
It has been said that the most important part of investing is “time in the market” rather than “timing the market”. There are so few, even professionals, that can consistently time the market. Time is critical and that clearly gives the youngest beginner investors the greatest advantage.
For example: If a 20 year old starts putting $100 per month into an account and earns a compounded 8% per year average until they are 65, they will have accumulated roughly $527,453. In this case, they invested a total of $54,000. However, if a 45 year old wanted to get to the same balance by the time they were 65, they would have to put in roughly $895 per month for a total invested amount of $202,800. Or if that same 45 year old was only able to put the same $100 per month in as the 20 year old, they would end up with significantly less at only $58,902 by age 65. So it is easy to see the power of time in compounding returns. Even if you change the amount invested or the compounded rate of return over the years, the biggest variable is the numbers of years. So the earlier an investor gets started, the less they have to contribute over time. They also don’t have to take on too much risk trying to make ridiculous returns trying to catch up.
There are various ways to start investing as a minor once the budget is completed and an emergency fund is established. The most common used methods to start putting additional savings away are as follows:
- UGMA/UTMA accounts – These accounts are generally used for minors. They are established with a custodian (most commonly a parent or grandparent) to help direct or watch over the assets of the minor. At the age of majority (either 18 or 21) the assets can then become the sole procession of the new adult. Most often we see these types of accounts opened and funded by a parent or grandparent to get the minor off to a good start, however, anyone can put money into these accounts for the benefit of the child.
- 401k – as soon as the new investor starts working for an employer that has the option to participate into a qualified plan, we would certainly encourage you to start participating in the plan. It can generally be for any percentage of your salary, but we would encourage someone to do as much as the budget would allow. If the employer has a matching contribution, try to at least do enough to max out the match.
- Traditional IRA’s – if you have maxed out the match in your 401K, an IRA is another way to get additional dollars into a qualified plan. For investors under the age of 50, you can contribute up to $5500 per year into an IRA, and it grows tax deferred until you take it out. It needs to be for retirement since there is an early withdrawal penalty if taken out before 59.5 years of age, unless certain exceptions are met.
- Roth IRA’s – these are similar to traditional IRA’s in their limits; however, these accounts not only grow tax deferred, the earnings are also tax free under current laws. They also need to be thought of as retirement assets due to the 59.5 years of age withdrawal issues. Contributions to both traditional IRA’s and Roth IRA’s can only be made if you have earned income.
- Brokerage accounts – if all options for qualified savings have been exhausted, or you don’t want to tie investable assets up until age 59.5, then you can use an after tax brokerage account to invest in just about any type of investment vehicle. These accounts, along with most of the others, can be established for as little as $25 per month.
Investing should not be rocket science. It does take a plan to be formulated and patience, but time is the most important element in the investing success. The get-rich- quick stories are few and far between and our minors or young adults will be better off knowing that starting early is in their best interest. Encourage them, mentor them, or get someone you trust to start them off in the right direction. It will pay off for everyone involved.