The financial and market disruptions are affecting more people than those in or near retirement. While years from their own retirements, young investors are viewing the recent market turmoil and concluding that the financial markets are not for them. They are reducing 401(k) contributions, taking early withdrawals, and deciding it is better to spend than to save. They worry that investing the little money they have will cause it to disappear. Traditionally it is tough to convince young people to save. Recent events make it harder.
Young investors should view this crisis as an opportunity. They have the most valuable asset: time. They can buy assets today at prices that are the lowest in years and will appear cheap in the future. They should not try to wait for a bottom in the markets and should assume it won’t occur for a while, perhaps years. But they do not have to worry when the markets find a bottom. What matters is that quality assets purchased today will be much more valuable when they want to retire.
Young investors should follow Warren Buffett’s example. He was criticized for amassing cash during the boom years. Recently, he has been investing that cash, having his companies take positions in Constellation Energy, Goldman Sachs, and GE. For the long-term investor who does not need current income from the portfolio, this is a good time to buy quality assets.
The best time to invest is when others are selling in a panic. An investor who can hold for the long term benefits by purchasing at times such as these.
Before investing, however, young investors need to learn lessons from those who recently suffered big losses. Lesson number one is to avoid what seem like the big, easy gains. These usually are very risky investments that depend on everything going in the right direction. If something goes wrong, the result often is not a temporary decline in price but a permanent loss of capital. Avoid large losses.
A related lesson is to avoid debt and leverage. These tools can increase returns when investments are profitable. But they also can result in permanent loss of capital if the asset’s price declines, even when the decline is only temporary. Time already gives young investors the most valuable leverage. They do not need to take the risk of adding debt to add leverage.
A useful tool for young investors is my 70%/2% formula. This was discussed in past visits. When someone invests over decades, the compounded returns will be so great that they will account for most of the portfolio. The formula says that when a young person begins investing early, after less than 30 years over 70% of the portfolio will be generated by compounded market returns as shown in the chart. Annual contributions of $3,000 builds to a portfolio of over $900,000 after 40 years at an 8% annualized return.
Here is what young investors should be doing today.
If you don’t have enough money to meet these minimums, save money in a bank savings or checking account until you meet the minimum level for an investment account.