Why Now Is the Time for Young People to Invest

January 12, 2023

2022 was a bloody year for stocks and bonds, with the following returns, including all dividends: 

 

The balanced portfolio failed miserably as volatility soared. In fact, it was the worst year in the history of the bond market, according to Edward F. McQuarrie, professor emeritus at the Leavey School of Business at Santa Clara University.  

The star performing asset class was cash. Even cash at the big bank earning zero did better. But with pain comes opportunity, especially for the younger investor with a long investment horizon. Here’s why it’s critical for younger people to invest more now. 

  1. Stocks and bonds are on sale. That is an obvious reason, though it sure doesn’t feel like we should be lining up to buy. I don’t know how financial markets will perform this year, but I do know they are priced lower than going into 2022. Though we feel it’s safer to buy after a long bull market, this just isn’t the case.  
  2. Best to learn about the pain of losing money earlier in life. Losing money hurts. In fact, Daniel Kahneman won the Nobel Prize for his work on prospect theory, which shows we get roughly twice as much pain from losing a dollar as pleasure from gaining a dollar. But when I lose 15% of my portfolio, it hurts so much more than when my 25-year-old son loses the same percentage. That’s because most of his net worth is in human capital (years of earning), while most of mine is in investment capital. So starting early helps one get used to market volatility to stay the course.  
  3. Harness the two most powerful forces in the universe—compounding and inertia. It is said that Albert Einstein called the power of compounding the most powerful force in the universe. While that may not be true, it is very powerful. Capitalism works in the long run. My son built his first portfolio when he was eight years old in what is now called the Second Grader Portfolio, comprising only the three funds mentioned earlier, and compounding has been good to him. In addition, putting money away to invest can not only become a good habit, it can harness the power of inertia that can carry though one’s entire working years. The inertia of living below his means and contributing the maximum to his 401(k) will likely continue for decades. 
  4. Costs have never been lower. My first stock purchase when I was a kid had a 5% commission, and mutual funds were outrageously expensive. Today there are broad exchange-traded funds to purchase with expense ratios close to zero. The annual expense ratios of the three ETFs above vary from 0.03% to 0.07% annually. 
  5. Build simplicity and tax efficiency. I’ve made more than a few investing mistakes in my lifetime. In addition, these low-cost and broad ETFs didn’t exist when I was young. It was either individual stocks with greater risk or expensive mutual funds. So getting out of my mistakes is costly from a tax –perspective, and my own portfolio is far more complex than I’d like it to be. I’d have to pay huge amounts of capital gains tax to get out of all of my investment mistakes. On the other hand, young people investing now can build a simple and tax-efficient portfolio like my son did. These index ETFs are tax –efficient, as they generally do not distribute capital gains.  
  6. It’s never been this easy. Today one can get started in investing using fractional shares of ETFs with as little as a few dollars. One can do it electronically and set up automatic withdrawals from a bank account.  

 

It's quite human to want to leave one’s nest egg in cash, but that is the one asset class nearly guaranteed to lose spending power to inflation.

Investing should be simple and about as exciting as watching paint dry. But seeing the next egg build up over long periods of time can be quite exciting, as it offers opportunities to pursue passions later in life.  

If you are young, I encourage you to start now, or if you have already started, stay the course. Never miss out on an employee match to a 401(k). If you are older and hopefully already reaping the benefits of your own nest egg, encourage the younger people in your life to invest today. 

 

Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for Barrons, AARP, Advisor Perspectives and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.   

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