There are many strategies and behavioral tactics you can use to be the best investor that you can be. One thing that is completely out of your control, however, is time.
As an investor, time can either be your best friend or your worst enemy. Investing early and often is the number one thing you can do in pursuing financial independence. Without taking advantage of time, you will likely have to resort to abject risk to build the wealth you desire. In this article I’ll explain why Millennials and young professionals have an investing edge.
Investing Early Allows Millennials to Take Advantage of Compounding
Have you ever heard that you “want your money to work for you”? I’m sure you have. This phrase is referring to building up some assets and allowing compound interest to take over. Saving a large nest egg while you’re young is the number one thing an investor can do and should focus on. The most common regret retirees have is they wish they’d have saved more money early on and taken their finances more seriously.
What is compound interest? Compound interest is the way your assets grow in the form of investment returns. It starts when the principal amount that you invest grows when the markets perform well. Your returns compound in future years because your principal and your past returns all increase in future positive markets. The more time you have until retirement, the more time is allowed for compound interest to work in your favor. As time goes on, this has a snowball effect and can allow you to build a sizable nest egg. (For related reading, see: Why Save for Retirement in Your 20s?)
A Look at the Effects of Compounding
Let’s take a look at some compound interest numbers and how time can become your best ally. In the following chart, I ran the numbers for two scenarios: saving $10,000 a year and $5,000 a year under the assumption that the average annual return is 7%. The Y-axis shows how much money you’d have accumulated at age 65 compared to the X-axis, which is the age at which you began those contributions.
Every five years of procrastinating has a huge impact on the future balance of your portfolio.
Now let’s say you want to make up the difference and save more as you earn more. What would it take to get to the same $2 million that you’d have accumulated if you’d have started at 25?
This table is why I cringe when people say things like, “I’ll invest once I make more money” or, “Once my kids are out of the house I’ll start investing.” Stop this train of thought. The time to start investing is now. It’s not about how much you earn, it’s about how disciplined you can be with your savings.
I know many families that can make saving $5,000-$10,000 a year fit in their budget. I don’t know too many that can find $40,000 per year to start playing catch-up. (For more from this author, see: How to Grow Your Retirement Plan to $1 Million.)
Tips to Maximize Your Time Advantage
- Automate your investments whenever possible. If you have a workplace retirement plan, you should set a goal of 10%+ to come straight out of your paycheck. If you automate the contributions, you will get used to living below your means.
- Starve and stack to build wealth quickly. Relax, I’m not actually asking you to starve yourself.
- Get your employer match as a bare minimum. If your employer plan offers a match, you’d better at least contribute enough to get the full match. This is a no brainer.
- Avoid lifestyle creep. Let’s say you get a 5% raise. First off, congrats, that’s awesome. The next thing you should do is increase your retirement plan contributions by 2-3%. That way, you’re enjoying more money in your pocket while also investing more for your future.
- Invest in a Roth IRA. For many, a Roth IRA is a great investment option if they already receive the full match or max out their work plan. This is subject to income limits. (For related reading, see: The Best Retirement Plans for Millennials.)
- Set up a budget. It’s important to know where your money is going. You may be surprised at the results.
- Have fun with it. Set up a three-, five-, and 10-year goal. Track your progress and reward yourself when you reach those goals.
- Avoid costly mistakes. One benefit of working with a trained financial professional is having an accountability partner involved in your decision-making, which can help you to avoid costly mistakes.
Millennials Have an Investing Edge
Stop waiting for some other shoe to drop before you start investing for your future. With discipline and some sacrifice, anyone can accumulate substantial wealth. The longer you wait, the harder it becomes. Get off the sidelines and get in the game. Your future self will thank you!
(For more from this author, see: Why You Shouldn't Keep up With the Joneses.)