Young Investors - How to Beat Your Parents at the Investment Game

Paul Merriman of Merriman Financial writes that investors in their 20s learn the 10 lessons he outlines, they should end up “with hundreds of thousands – maybe even millions – of extra dollars to spend”, in other words, much better investor than most people their parents’ age.

These lessons are not hard. They’re easy. My daughters, ages 14 and 11 respectively, have no trouble with them. I don’t think you will, either.

You will want to read the entire article and answer the simple questions after each lesson.

LESSON 1: Save vs. Spend.

You can’t be a successful investor unless you’re an investor. And you can’t be an investor unless you have some money to invest. To do that, you have to save some money instead of spending every dollar. Is that so complicated? Yet you would be amazed at how many people just can’t seem to set money aside for the future.

LESSON 2: Save Now vs. Save Later.

If you save $100 when you’re 25, at a growth rate of 10 percent your money will be worth $4,526 when you’re 66. That’s $45.26 for every dollar you save. If you wait until you’re 30, you’ll have $28.10 for every dollar you save. If you wait to age 40, your $1 will grow to only $10.83. Wait until you’re 50? Forget it: $4.18.

LESSON 3: Save More vs. Save Less.

I recommend you get in the habit of saving 10 percent of what you earn. Live on 90 percent, and you won’t suffer very much. If you need more spending money, get a second job. (You’ll have more to spend and less time to spend it.)

LESSON 4: Stocks vs. Bonds.

Buy a stock and you’re an owner. Buy a bond and you’re a loaner. Which pays more, stocks or bonds? In the 75 years from 1931 through 2005, large U.S. stocks earned annualized returns of 10.5 percent. That meant that an investment of just $1 grew to $1,787. In the same 75 years, long-term U.S. government bonds earned returns of 5.5 percent. That meant an investment of $1 grew to $55.45.

LESSON 5: One Stock vs. Many Stocks.

But more than 30 percent of the individual stocks you could have bought in 1996 are worth less today than they were then. If you bought a stock chosen at random and held it for 10 years, there’s three chances out of 10 you would have lost money.

By contrast, if you had invested in 1996 in a mutual fund that invested in U.S. stocks, there’s less than a 1 percent chance that fund would have lost money. This is why millionaires invest in lots of stocks. You can do that too, using mutual funds.

LESSON 6: Pay Taxes vs. Don’t Pay Taxes (legally, of course).

As soon as you start earning income that you have to report on a tax form to the IRS, you are eligible for one of the best tax breaks you will ever get from the federal government. It’s called a Roth IRA; the letters stand for Individual Retirement Account. You could think of it as your own private pension.

LESSON 7: Load Funds vs. No-Load Funds.

When you invest in a load fund, you pay a sales commission. When you invest in a no-load fund, you pay no sales commission. Fund loads are complicated, partly because the fund industry wants them to be hard to understand.

LESSON 8: Low Expenses vs. High Expenses.

All mutual funds charge expenses, and investors who own a fund share common costs. But some funds charge a lot more than others. The expensive ones argue that you get more, but this is a case where the statistics indicate that the opposite is true. Every dollar you pay in expenses is a dollar of your investment return that goes to somebody else, not you.

LESSON 9: High Tax Efficiency vs. Low Tax Efficiency.

This is a variation of Lesson 8. Recurring expenses act like an anchor being dragged behind a boat. The same is true of taxes. Some funds are tax-efficient because they don’t buy and sell their stocks very much, so they don’t create a lot of capital gains on which their shareholders have to pay taxes. Some funds are specifically managed to keep taxes low.

LESSON 10: Automatic vs. When You Feel Like It.

Put your investing on automatic pilot. You can put your savings on automatic by having money taken out of your paycheck or your bank account regularly so you don’t have to think about it.

To Summarize:

Don’t spend everything you earn. Make your savings automatic, and start saving money as early as you can. Invest 10 percent of your pay in low-cost, tax-efficient no-load mutual funds that invest in stocks instead of bonds. To whatever extent you can, make your investments in a Roth IRA or a Roth 401(k).

Put all these lessons into practice and you won’t be sorry. That’s a promise.

Read the entire article.