Saving for retirement is not something at the forefront of most 20 something year old minds. With the allure of travel, cars, partying or just meeting the cost of everyday living expenses, thoughts about saving money for the long term often take a back seat.
Many think that one day their future well paying job will help make up for lost time, however, as your 40 something year old self will find out, this is seldom the case.
Here is a list of 7 things I would tell my 20 something year old self from what I know today.
1. Pay yourself first
The idea behind this concept is to always save a portion of your earnings before you do any spending. Doing this the day you are paid will create discipline and help reap the benefit of compounding returns (see below) – two things that will pay significant dividends in the future, as your balance grows.
2. Don’t try to time the market
Over the last two decades, the Standard and Poor’s 500 index has returned approximately 8.2% per annum. However, if you missed the best 10 trading days in that 20 year period, returns would have dropped to 4.5% according to analysis by the Schwab Center for Financial Research. The moral of the story, timing investment decisions is particularly difficult.
3. Take advantage of compounding
Compounding is essentially the return you get on your investment and over time, it can really add up. Take the following example:
Sarah is a disciplined 19 year old and has decided to start investing $300 of her savings into the share market each month. If she does this for a total of eight years and then stops contributing completely at the age of 27, she would have outlayed a total of $28,800.
Bob has also decided to start investing $300 per month, however he is already 27 years old. He continues to do this until he turns 65 for a total outlay of $136,800.
Based on a 10% annual rate of return, at the age of 65, Bob will have a portfolio worth approximately $1.58 million. However, at the same age, Sarah will have a portfolio worth approximately $1.69 million even though she has contributed $108,000 less than Bob.
This shows that even though Sarah has contributed less funds than Bob, she has made more money by starting earlier and allowing for compounding to occur.
4. Learn to control your (investment) emotions
Markets are going to rise and fall over time. Invariably the investment mantra that you should ‘buy low and sell high’ plays out inversely due to investors trading on two emotions, greed and fear. Learning to control your investment emotions and refrain from irrational decision making in conjunction with a robust, long term strategy, can help produce successful investment outcomes.
Diversifying your investments across and within different asset classes can help to reduce your overall risk. This may involve investing through small, medium and large cap shares, domestic and international markets, corporate and government bonds with different payout dates. This means that if one sector or asset class underperforms, you will still have other investments to keep you afloat.
6. Be conscious of fees
Even if you think you are doing all the right things, if you’re not conscious of the fees you’re paying, your returns may get whittled down over time. When thinking of investment fees, most people think ‘financial planning’ fees. However, the fees I am referring to are the hidden ones. If you are purchasing managed funds, it is worth looking at what the ‘management expense ratio’ (MER) or ‘indirect cost ratio’ (ICR) is for each fund. This is the investing holding cost that you pay to the fund manager.
As an example, if we consider Sarah from above who is now 27 years’ old and her portfolio is worth $40,000. If she decides to continue investing $300 per month into a managed fund that charges an MER of 1% per annum, based on an annual return of 10% (net return 9%), her portfolio will be worth $2.17 million by age 65.
Now, let’s say she invests into a managed fund that also has an average return of 10% per annum, however the MER is now 0.5% per annum (net return 9.5%). Over the next 38 years, the fund will grow to $2.52 million, an increase of $350,000.
7. Speak to a professional
If you are considering investing for the first time, seeking professional guidance can help prevent you from making early mistakes and potentially missing out on significant returns over time. It is not uncommon for someone to be influenced by friends or family at the Sunday bbq lunch where the talk may be centred around a speculative stock that is about to take off. These types of ‘hot tips’ may pay off, but more commonly they end in disappointment and create hesitation to ever invest at all.
If you do wish to speak to a professional, DPM offer an initial, obligation-free consultation for those looking to start their first investment, or perhaps want a second opinion.
* The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.