7 Rules for Investors Under 40Submitted by Reby Advisors | Certified Financial Planners | Danbury, CT on September 4th, 2020
By Devone McLeod, CFP®, September 4, 2020
My colleagues Doug Kuring, Antonio Gonzalez, and I recently hosted a webinar for young professionals titled Taking Control of Your Money Before 40: Foundational Wealth Building Strategies Designed to Achieve Big Financial Goals.
This article focuses on seven key points from the webinar on how to invest in the stock market when you're in the pre-retirement wealth accumulation phase of your financial life.
Start investing as early as possible.
Time is money. Especially when you own assets that increase in value and generate interest or pay dividends.
The charts below illustrate the massive impact of contributing to a 401(k) account sooner rather than later. Sarah (left) consistently contributed to a 401(k) account from age 25 through 65; Jeff started 10 years later.
What a difference! Both earned $50,000 per year, invested 10%, and got 8% returns, yet Sarah’s portfolio is now more than twice the size of Jeff’s!
How did this happen? Because the contributions Sarah made between ages 25 and 35 continued to generate compound returns for 30 years before she retired at age 65.
What if you haven’t started yet? As Confucius said: “The best time to plant a tree is 10 years ago. The second-best time is now.”
Consistently invest a set percentage of every paycheck.
Automatic 401(k) contributions or direct deposits into an investment account is probably the easiest way to build wealth over the long run.
So, what percentage should you invest?
All things being equal, the higher the amount, the faster you will accumulate assets and reach your wealth goals. However, it’s even more important to select an amount that you can stick with. Your cashflow should cover living expenses, debt obligations, and lifestyle expenses – including fun!
As my colleague Doug Kuring mentioned during the webinar, “the last thing you want to do is max out your 401(k) and then stop investing altogether… if you’re eating peanut butter and jelly at every meal, that’s probably not sustainable.”
Invest in the stock market to fund long-term goals.
Many young Americans – having lived through the Dot-com bubble crash, the Great Recession, and the Coronavirus Recession – do not trust the stock market.
Yet disciplined investors who remained invested through these challenging economic times have been rewarded for their patience.
A hypothetical $10,000 investment in an S&P 500 index fund back in 2000 would have grown to more than $30,000 in 2020 (with dividends reinvested). Historically, the S&P 500 has generated average annual returns of approximately 10%.
Remember our favorite investor Sarah who earned 8% returns on her way to a $2 million retirement? Had she invested in all bonds, her portfolio probably would not have reached even half of that amount.
Continue investing during bear markets.
Legendary investor Warren Buffet described his company’s investment philosophy as, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
In other words, buy low and sell high.
Our natural loss aversion makes us fearful of investing when the stock market performs poorly. However, the lower the price, the greater the number of shares you can purchase; and that means you’ll have more shares eventually to sell.
Here’s an example:
Sarah starts investing $400 per month in an ETF, purchasing 40 shares for $10 per share. The price then falls to $8 per share the next month. If she takes advantage of the 20% drop in value, she can now buy 50 shares for the same $400. Now, she owns 90 shares.
Fast forward 20 years. The ETF trades at $50 and those 90 shares are worth $4,500! By purchasing additional shares during the temporary decline in price, Sarah actually increased her investment gains.
Invest in ETFs and mutual funds to reduce risks.
Everyone dreams of buying the next Apple, Amazon, or Netflix, but even the experts have a poor track record of picking individual stocks or market timing. In the worst-case scenario, a company goes out of business and shareholders to lose 100% of their investment. For every Google, there’s an Enron.
Stock investors reduce their risk through diversification, owning a range of assets across industries and company sizes. When a single company fails or an industry struggles, other investments may thrive. However, it takes a ton of money to properly diversify when investing in individual stocks.
For this reason, we generally recommend investing in exchange traded funds (ETFs) and mutual funds with low expense ratios. These funds pool money from thousands of other investors to create a diverse portfolio of dozens, hundreds, or even thousands of stocks.
Here at Reby Advisors, our client portfolios typically include between 13 and 15 asset classes, including both domestic and global investments. Investing beyond U.S. borders aims to accomplish two goals: diversification and capitalizing on potential growth.
The United States is a mature economy. When gross domestic product (GDP) grows at 3%, that’s considered a really good year. Many emerging economies grew 5% - 11% in 2019, as illustrated in the map below from the International Monetary Fund:
If you’re just starting to invest, the first fund you will probably invest in will be a U.S. equities fund, such as an ETF that aims to mirror the performance of the S&P 500. Over time, however, if you want exposure to global economic growth, invest beyond U.S. borders.
Here's a clip from the webinar:
Pay attention to fund fees.
All mutual funds and ETFs charge fees to investors. Even small fees add up over time. Remember, patient long-term investors benefit from the magic of compound returns, and the fees you pay this year is also money that won’t be able to compound over time.
The chart below from Vanguard illustrates the cost of 2% annual fees on a $100,000 investment that earns 6% annual returns over a 25-year period—$170,000!
Moreover, research suggests the old adage “you get what you pay for” does not apply to fund fees. Vanguard research actually shows that both stock funds and bond funds with low costs outperformed funds with the highest fees over a 10-year period.
The lesson: be aware of fees and how they can impact your success as an investor.
Learn More About Financial Planning for Young Professionals
If you are interested in watching the full webinar and learning more about paying down college debt, investing in real estate, and taking care of a young family, go to: events.rebyadvisors.com/money-under-40
Please don't keep this webinar a secret! Share it with a friend of family member who may benefit from learning more about the topic!