The seeds are sown in childhood, when you start young saving in your piggybank and investing it. As they say, no age is too early to invest. Suppose, when you’re 10 years old, you start saving $100 per month (which, with a bit of effort, you could!), then by the time you reach your retirement age of 60 years (hopefully, you’ll never retire!) – you will have saved $60,000 – and this doesn’t account for the effects of compounding interest. If you begin saving at the age of 50, then you need to set aside $500 per month to get the same amount. So the earlier you start, the better. It gives you adequate time to test the field and amass wealth.
Life is like a snowball. The important thing is finding wet snow (opportunities) and a really long hill (longterm).
– Warren Buffett
But it’s not an overnight decision. As Warren Buffet says, the longer it rolls, the bigger the size of the snowball.
Those crucial nitty gritties
Learning to curb spending is the first step to saving. Saving small amounts on a weekly basis puts a cuff on your spending habits.
Before spending, check various options and try to get the best deal. If using credit, use it judiciously. “Getting things on credit is like using your future income for today’s expenses” – this from kids cartoon character Doraemon. (No wonder the Japanese are so good at living simply and safely!) Again, the interest on your debt should never amount to more than 30% of your net income.
Also, keep targets as percentages rather than as specific amounts. Then keep increasing them. For example, if your savings are 7% of earnings in the first year, increase the percentage every year.
But saving is not enough. When inflation reduces the value of money, investing and earning at a higher rate is the only way to beat it.
There are many options for investing and an even higher number of wealth advisers. So keep track of the market pulse to make the right investment decisions.
If you don’t know where you’re going, you’ll end up somewhere else.
Clarity around your requirements is the first step to making right investment decisions. Have a precise idea of why to invest, what you want to achieve and how long you have to achieve your goals. These could include building retirement savings, contingency plans, short-term goals, education of children, owning a property, clearing debts, long-term growth, etc. Now rank these requirements.
Immediate income might be enough to meet your short-term goals. But meeting bigger goals demands more time and better planning. Selection of your investment tools is important and should match your investment goals.
The simplest way to invest is through a savings account or fixed-deposit (term deposit) accounts in bank. Though they are easy to open and offer liquidity, the interest they pay is low. Credit unions or co-operative banks pay higher interest rates to attract depositors. But the risk they carry is also higher. So it’s better to use these as interim carriers until you accumulate more wealth and find a better option.
Start an emergency fund
In turbulent economies, it pays to be vigilant. Set aside a fund to meet any contingencies that may arise from a job loss or other emergency. This fund makes a person more confident. It should be able to cover your expenses for at least 3-6 months. As they say, a stitch in time saves nine.
Retirement life is expensive, so proper retirement planning is crucial. You’ll need at least 70% of your pre-retirement income for retired life. Besides government-initiated contribution plans, many private pension plans are also available. Choose one with lower taxes and higher income. You should not touch your retirement savings for other purposes.
Then there are those short-term goals such as buying a car or electronic gadgets. Minimize the use of credit as much as possible for these. Instead, create a fund, and allocate a portion of your savings to this fund for a period of time. Then use all or part of the accumulated savings to buy what you want or need.
Equity or real estate?
The two most powerful weapons in investing are time and a high tolerance of risk. Equipped with this, the aim of young investors should be growth. The option that best matches this need is equity. In fact, equity and real-estate investment has proved to outdo inflation.
Investing in stocks of a company means you buy a share in the the ownership of the company. So you need to understand the ‘what to’ and ‘how to’ of investing. You can trade these shares/scrips on the stock markets. Learn the basics of stock market and build knowledge.
Reading, Researching and Referring are the 3 R’s, which help you cross the sea. Select a few stocks (say, 5) with help from an experienced person or from the knowledge you gain from reading. Follow these companies and start understanding the basics. You have to get wet to learn swimming.
You can’t cross the sea by standing and staring at the water.
For starters, don’t try day trading unless you want to learn the hard way. Always diversify and invest across companies and sectors. Follow Warren Buffett’s policy: “Only buy something you’d be perfectly happy to hold if the market shuts down for 10 years.”
You can also use the services of traders, portfolio managers and technical analysts. But over the long term, the investor himself should hold the baton. He has to take responsibility for his own success.
The easy route may not be the best
If the 3R’s frighten you, then you can start equity investing through mutual funds. A mutual fund is a group of shares traded together as a single entity and managed by professionals. So investing in mutual funds means you are investing in many companies/instruments at the same time. There are different mutual funds with different objectives. With a bit of reading you can select one that matches your needs.
Yet, given the track record of the mutual fund industry, you might be better off managing your own portfolio. This takes a little extra effort. Based on a SPIVA report, only 12.77% of American mutual funds outperformed their benchmark in 2014. This is not a special case, as the underperformance rate over the past three years is 76.77%. The five-year rate is 80.82%.
Save small, save often
Yet another tip is to save regularly – SIPs (Systematic Investment Plans) have the advantage of cost averaging. When you invest the same amount each month, you buy more units when the Net Asset Value (NAV) of the fund or stock is low. The reverse happens when the NAV is high. But this will average out your per unit cost and you’ll benefit in a future bull market.
Also, to optimize risk, you need to invest in debt instruments. Government bonds and debentures issued by corporations are the options available. But check the credit rating of the latter: these investments have fixed interest rates, so the return is also low. When interest rates are lower, bond prices are also lower. When interest rates are high, returns from these options are less than those from equities. Referring to various stats, the average annual return on bonds since 1928 is 6.7%. For stocks, it is 10%. At the same time, as you move up the tax brackets, there are some tax-free/tax-saving bonds. Those can bring down the total cost of investing.
In developing countries, investing in life insurance is crucial. Though this is not a traditional investment avenue, it is tax-exempt, so this averages your cost of investment.
Don’t keep all your apples in one basket
Create a portfolio that is diversified across various asset classes. Have an equity- based portfolio with minimal allocation to debt instruments. This helps you contain the volatility of the market.
Eternal vigilance is the price of eternal development.
It’s not yet time to sit back. The economy is changing, and so are the patterns of returns on investment. Keep a track of the RoI (Return on Investment) of various investment options. Check your portfolio on a regular basis and make changes to it whenever necessary.
Starting on your own
Youngsters can also think outside the investment box by starting a business. If you’re passionate about this idea, then go for it. This might turn out to be your most profitable investment. Remember Peter Lynch’s words: “Go for a business that any idiot can run – because sooner or later, any idiot probably is going to run it.”
The power of compounding
Don’t forget the magnanimity of compounding effect. If you start investing when you’re young, you can take advantage of compounding returns. Also plough back the returns into your investments. Compounding dramatically accelerates the growth of investments.
The hitch: capital gains tax
There are no freebies in the investing world. Return on investment is subject to capital gains tax. Consider this when you make investment decisions. Before investing, research the type of investment, its period and the tax implications. Over the long term, awareness and knowledge of this will help you achieve greater profits.
The bottom line
From an investment perspective, you can’t change the past, because it is gone. You can however, change your future – by taking charge of it.