Ironically, it is more important to invest when you are young since the more time you have, the more time you have for your investments to compound and grow. Unfortunately, most young people are just starting jobs and/or going through school and have very little to invest. Then again, if you are still living at home and don’t need to worry about shelter and food, you might be able to put some money away if you give up a few nights out with friends, live without a car for a while (or live with a really cheap car), or make other sacrifices. Understand that you will be weird, but then again normal people don’t become millionaires at 40.
The most important thing to do while you are young is to set up your cashflow plan such that it is a normal thing for you to be saving and investing. “Cashflow” is how money flows into and out of your hands. “Normal” people have cash flow into their hands from their jobs and then instantly flow out of their hands again to pay for expenses and various junk they buy on impulse, as shown in the figure below.
People who will be wealthy are always directing a portion of their paycheck to savings and investing. Eventually the assets they acquire from investing start providing additional cash, augmenting their paychecks. It is much easier to start out putting 10% of your check away than it is to reduce your expenses later, so even if you have a small paycheck, it is important to start putting money away from the start. Also, if you save up and pay for things with cash, you’ll have hundreds of thousands of dollars more in your lifetime than will everyone around you who is always paying interest. That makes it easier to become wealthy too. A wealthy person’s cashflow looks like this:
At first it may seem hopeless. After all, even if you earn a 20% return on $1000, which is a very good return, you’ll only be getting $200 per year, which is less than one week’s paycheck, even at minimum wage. Over time, however, if you continue to invest regularly and allow the money to compound, the returns will grow. Eventually the amount you’ll be making from investments will be far greater than what you make from work.
The question then comes down to how to get started. There is the old saying that it “takes money to make money”, and there is certainly some truth to that sentiment. It’s also true that it is far harder to earn your first million than you second. Still, you need to get started somewhere. Let’s look at two scenarios:
Scenario 1: Living on your own
If you are living on your own and are supporting yourself (or will soon be doing so), the first thing to do is to save up an emergency fund. This should be enough money to keep you fed and sheltered for at least 6 months. This is the money that keeps you from going into debt when the car dies of you have an emergency room visit. If you ever need to use your emergency fund dollars for any reason (and a vacation is not an emergency) you should focus as much attention as possible into replenishing the funds as soon as possible.
The second thing to do is to save up cash and buy a used car. Start with a $2000 car that is reasonably reliable. Save up another $2000 and sell the first car (it will probably still be worth about $2000) and buy a $4000 car. A ten-year old Camry or Honda should last 8-10 more years, allowing you to continue to save and build your resources without a car payment. Just put $400 per month away for that 10 years and you’ll have $40,000-$80,000 more than your friend with the car payment.
Once you have the emergency fund and the car squared away, you’re ready to start investing. Start a special account for investing dollars and direct a certain amount away each month, say $200-$500. (Note that this assumes you are able to put away the $200-$500 after you have paid all of your expenses. It will do you little good to invest if you are carrying credit card balances. You will never keep up with credit card interest payments.)
Scenario 2: In High School/College with Support
If you are in high school and are working, or if you are working in college and your parents are nice enough to still be providing your room and board, you may be able to start investing a little bit early. As with the case where you are living on your own, you need to start directing some funds into a special investment account.
Starting to Invest:
Once you have a few thousand dollars in your investment account, you are ready to start buying stocks. An easy option is to simply pick an index fund (Vanguard is a great fund family with low fees and a good selection). A good first fund is a large cap growth fund or a small cap growth fund. Once you have purchased your first shares of the fund you can start sending in regular payments to purchase more. As you get to about $6000 in the first fund, save up a few thousand more dollars and pick another (if you bought the large cap, start buying shares in the small cap fund, or vice versa). Once you have about $6000 in each of the first two, maybe pick an international fund.
Continue until you have about 5 different funds. From then on it is simply a matter of buying more shares of whatever fund has the least value at the time you have cash, and maybe selling a few shares if one of the funds does a lot better than the others (for example, one fund is worth $40,000 while the others are each worth about $20,000, you might want to rebalance a bit). Avoid selling if you can, however, as that will trigger capital gains taxes.
Another option is to start buying individual stocks. (Note that there is a very real possibility with this option that you can lose an entire position since companies do go bankrupt from time to time. Never put more into a single stock than you can afford to lose.) In this case you would save up until you had a few thousand dollars (enough for 100 shares) and then buy shares in a company that you feel has good growth potential for the next decade or more. This means that the company has been growing (earnings have been increasing regularly by 10-15% per year) and the business still has a lot of room for expansion. Look for a company you would want to be a partner in long-term rather than worrying about price patterns or news that you hear. In other words, focus on the business rather than the stock movements.
Once you have acquired your first shares, save up and buy a second stock in a different industry. Keep doing this until you have 5-10 different stocks. Then start to build up your positions, buying whichever company seems the best value when you are ready to buy. Trim off stocks that don’t meet expectations. Also sell portions of stocks that do really well and grow to the point that you couldn’t afford the loss of the position.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.