For this post I have enlisted the help of Haydn from Perpetual Prudence. He will be talking about the main benefits of starting investing early, both financial and non-financial, and why young people should invest as soon as possible!
I know what you’re thinking. You don’t need to worry about investing – that’s something for middle-aged people to think about. Besides, you don’t earn that much at the moment. You need that money to go on holiday, get drinks with friends, go to restaurants, etc. You need that money to live, you can’t afford to invest right now. But, young people should invest if they can.
Whilst this is somewhat true, most people with this mindset underestimate the importance of starting the investment journey early.
Sure, it seems that some do, or are at least thinking about it – 75% of young people in the UK have invested or are considering investing. But this isn’t really reflected in actual investing statistics; only 12% of the UK population invested in the stock market in 2018 and only 2.2M people held a stocks and shares ISA in 2019.
So it actually seems like young people know they should invest but are convinced that there are legitimate reasons why they can’t (there aren’t), are unclear as to exactly why they should, or underestimate the benefits of investing and the costs associated with not doing so.
In this article, we’ll talk through these benefits, making it clear why young people should feel compelled to start investing now.
Practice with low consequences
When you learn to ride a bike, whoever is teaching you doesn’t chuck you onto a main road straight away. You first learn in a safe, low-risk environment (on a patch of grass with someone initially holding the bike as you furiously peddle). An environment in which failure and mistakes don’t have severe consequences.
The same should be true for investing.
When you’re young, investment decisions are far less important than when you’re older. This is primarily because you’re earning relatively little compared to future you. Any money lost now or invested unwisely is not going to have a significant financial impact on future you. Secondly, there are less-severe consequences of mistakes: you are milessss away from retirement and your financial responsibilities are likely relatively non-existent.
Acclimatising to reality
So if practice is required, why not practice with fake money, or on paper? You could maintain some record of investments that you “would” have made and use this to test/affirm certain strategies.
The biggest problem with this approach is that you have no skin in the game. There are no consequences of bad decisions, just your ego being slightly deflated. You might be tempted to take more risk, not put in as much effort, “invest” larger amounts, etc. because if you lose money you only lose money…on paper.
Practicing, investing, learning with actual, real money gives you financial incentive to do these things to the best of your abilities. I have found, remarkably, that when my friends start earning enough money to make investments they all of a sudden become very interested in investing. Weird.
Using real money has the additional benefit of, well, reality. You are using real platforms and getting used to these platforms. You are becoming acquainted with costs and fees. This way you will build good habits for life.
Building habits early
It’s better to build these habits young when it’s easier to do so. It’s like diet. When you’re younger you can get away with eating unhealthily. But when you hit middle-age those bad habits start to catch up with you, the consequences of which being painfully visible. If you build the habit of eating good food when you’re still young, this won’t be a problem.
Again, the same applies to investing. When you’re young, you don’t have many financial responsibilities, and there is no immediate need to invest. You can “get away with” not investing…but this apathy can hurt you further down the line.
What you do have when you’re young is more control over your outgoings. You can live significantly below your means, if you want to. This means you can invest a significant amount of your income, if you want to. You also have lots of free time. Some of this time can be easily used for learning – learning about investing.
When you invest early you actually, well, invest. You save money that earns some type of return for use at a later date. Obviously, the more you invest at an earlier age, the more money you are likely to have available to you later in life. You are also less likely to be reliant on future income to cover future expenses. That’s kind of the whole point of investing.
But it gets better. Investing early – in something like a pension, for example – gives you the key benefit of time. Why is time important? 3 main reasons.
I’m sure most of you have at least heard about the benefits of compounding. So I won’t bore you with endless charts and tables demonstrating the effect. All you need to know is that your investment pot doesn’t grow in a straight line, it grows at a faster rate. This is because not only do you receive returns on the money you invest, you also receive returns on the returns of the money you invest. This can make a surprisingly significant difference, especially over long time horizons (see for yourself).
Time also reduces the proportional impact of randomness on returns. These returns over a longer period of time are more likely to be a reflection of the true underlying rate of return for that asset, rather than short-term “random” price movements.
This is important because in financial markets there does seem to be some sort of inverse relationship between risk and return. There is no free lunch. It seems as if markets self-organise to some extent to ensure assets with the highest returns are accompanied with the highest level of risk.
So young investors can afford to invest in riskier (hence, usually higher-returning) assets because the short-term volatility associated with these assets is likely to get washed-out in the long term.
One final thing to note is the fact that starting investing for some type of goal earlier reduces your required rate of return. The return needed to meet your goal(s) is lower, meaning you can invest in safer-but-lower-returning assets and still be confident of hitting your goal(s). This is particularly relevant for important goals that you can’t afford to miss.
Haydn is the author of perpetualprudence.com. This is a blog that takes a step back from the tactics and tools of personal finance and investing to consider the why behind normal recommendations. In doing this he touches on personal finance, investing, probability and statistics, and more! He’d love to collaborate and support others interested in similar topics. Do drop him a message @HaydnMartin_ on twitter to get in touch!
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