As a young investor, newly introduced to the world of money management, this is how you should get started; figure out how much to put in stocks and how much to put in bonds and cash. But how do you do that? Luckily for you there’s one simple rule; subtract your age from 100 and invest that percentage of your assets in stocks, and the rest in bonds or cash. You see, there’s wisdom behind this.
When you’re young you can seek out larger returns by taking larger risks (hence more equities and less bonds and cash). This is because if a young investor loses money, they have time to recover the losses by working and earning a salary. Well easy – thanks SMIF for the sound advice, I’m going to invest most of my money in stocks right away.
Now hold on a second. I never said this wisdom was correct.
Imagine you’ve just graduated and now have a full-time job. You’re saving up for a down payment for your very first home, and perhaps even a wedding. You’d be out of your mind to have that much money in stocks. If the sharemarket plummets, you’ll have nothing to cover your downside. And what if you suddenly experience a rainy day? Perhaps the company you work at decides they don’t need you anymore, or you get a divorce. What do you do then?
Now I’m not saying the age rule doesn’t work for anyone but there are definitely a few things every young investor should consider. Here are some tips worth following:
- Your personal finances will matter more than your portfolio. Pick up some good habits and throw away the bad and you’ll be setting yourself up for life.
- Spend less and save more. The amount you save should be a well thought out percentage of your income. Increase this percentage each year.
- Avoiding large mistakes can be really difficult. Try to learn from mistakes, your own and from other people before you.
- Ask a lot of questions. If a stock falls in value, a young investor might expect it to bounce back up, but a lot of the time it is down for a reason. If you are able to ask why you are also able to find out.
- Investing isn’t free. You’re going to be charged fees. Find out where you can get good service for less. Or perhaps you want to use a professional. Just know that you’ll be paying them a percentage of your portfolio, plus a flat fee.
- Don’t invest money you’ll need soon. If the market goes down, you won’t have enough time to recoup your losses.
For a young person, a portfolio with 80%+ allocated in stocks makes sense in theory, but in the real world, it all comes down to knowing what you’re getting yourself into.
For more on asset allocation and a lot more you can read Benjamin Graham’s The Intelligent Investor. Though last updated in 1972 the teachings behind his text remain relevant to this day.