Investing isn’t just for the rich. You don’t need to be rich or know much about investing in order to invest in mutual funds, bonds, stocks, etc. Here are a few smart financial moves for young investors that can help them grow their wealth much faster than they may have been expecting.
Focus on growth-type investments
If you are young and just starting out, then you can afford to take more risks than when you get older. When you are at the beginning of your financial journey, time is on your side. Your portfolio should be oriented to invest consistently in growth-type investments (stocks & mutual funds) rather than income-producing investments (bonds & GIC’s). This is because the younger you are, the longer your money has to grow. But even though stocks have historically earned higher returns than other major asset classes over long periods of time, past performance does not guarantee future results. The stock market goes up and down, which means there will be times when it feels like you are throwing away money by holding on to those stocks. So why bother? Why not just put your money into the bank where it is insured and earns next to nothing instead?
It’s true that one, five, or even ten years doesn’t make a big difference for someone who is young, but over time compounding returns will dramatically change your net worth. Let’s go back to our previous example: A 50-year-old with $200,000 saved up in real estate vs. stocks would have $817,727 vs. $1,581,206 respectively (after 30 years of earning 7% annually before expenses). That comes out to an extra $764,479 that the investor who choose the stock market over real estate would have earned (which they could then invest again and watch compound).
Pay off debts promptly
Credit card debt is the worst form of debt. You are paying interest to borrow money. You should pay off any debts as quickly as possible, because even if you are earning 10%, 5%, or 0% return on your investments, that is still better than -5% to +25%.
Paying off a credit card with 3% interest is just not worth it, because you can be making much more investing that same money elsewhere. Even if the minimum payment on the credit card was 1%, that would still be better than nothing. This does not mean stop using your cards completely, though! If you use your cards responsibly and don’t carry a balance, then by all means keep them open because they will give you cashback.
Invest in a high-interest savings account
It doesn’t matter if you can’t invest a lot. If you take all the money you would spend on your daily latte and put it in an online savings account, like Ally Bank, at 1.5%, then after 10 years, that $100 per month will turn into almost $18,000! Investing is not complicated; pay yourself first by saving first. (There are actually several other benefits to this approach beyond just growing your wealth.)
Taxes should be efficient
Tax efficiency should be considered when investing as well. This means that if you buy individual stocks or funds with high turnover (meaning they trade quite often; i.e., the fund manager is actively buying and selling stocks), then you will be paying a lot of capital gains tax. This means that when you sell the investment, you will have to pay taxes on all the gains made in the investment since purchase, not just on the money you earned from your investments. If an investment only has a 5% gain, but there was a 20% gain due to turnover, then it would be better to own a similar investment that has NO turnover so that you only pay taxes on 5%. Therefore, if you are going to invest in individual stocks or funds, seek out those with low turnover.
Diversify with index funds
If you don’t have time to read all the filings that each company has published, then index funds are for you. An index fund follows a market index, which means it just buys all those stocks in order from whatever companies make up that index. For example, if an index fund follows the S&P 500 Index, it will buy shares of every company in the S&P 500. This gives you instant diversification as well as low turnover (meaning fewer capital gains tax). In fact, according to Hedge Fund Research., 88% of large-cap fund managers could not beat the S&P 500 index funds.
Investing can be a big part of a plan for people to become financially independent. You don’t need a lot of money in order to invest and earn money from your investments, making them grow very quickly over time. Be smart and patient with your investment choices and undertakings.