Why You Should Start Investing Early?
How much thought do we give to savings and investments when we are young and are making fancy plans for our first salaries or stipends? For many of us, any thoughts of getting serious about personal finance only come when we are well into our careers. So when is the best time for us to start investing?
Is it when you get your first job? Should you start investing right after marriage? Or should you start when you’ve finally bought that car you always wanted?
Well, both mathematically and intuitively, the simple answer is that the right time to start investing is as soon as you can start investing. Allow us to explain.
Warren Buffet’s Secret: He Had a Head Start
Here’s an interesting story.
Many of us have heard of Warren Buffett, also known as the Oracle of Omaha. He’s widely known as one of the successful investors. But did you know that he was only 11 years old when he made his first investment? At 11, he bought his first stock. By 13, he was filing his first taxes. And by age 15, he had a net worth of $6,000. Impressive, right? Consider this graph showing the spectacular change in his net worth over the years.
Warren Buffet’s Net Worth Over the Years [Based on data from MicroCapClub]
As is evident from this, Buffett’s net worth took a while to reach greater heights. In the initial years, the gains were smaller. But consistent investments and financially sound decisions over the years paid off and he hit the $1 billion mark at age 56. Even after that, his wealth continued to grow exponentially over the subsequent years.
The power of compounding is the primary reason why it is important to start investing early. Longer the time, the higher the yield. And as the sum increases, the new returns are even higher. Based on this article, here’s a graph showing the trends for three different investors.
How Portfolios Grow Based On When You Start [Based on data from USNews]
As the graph indicates, a difference of ten years can have a tremendous impact on the returns. This is because the time value of money increases. Moreover, an investor can get even better returns because they begin to learn about finance at an early age.
Another observation here is that even the difference in the value of returns is higher in case of the persons who started investing at age 20 and 30 as compared to age 30 and 40.
This, in visual terms, is the power of compounding. Since investors generate returns on the initial returns as well, they get a headstart that is impossible to beat - accumulating Rs 520,000 versus Rs 100,000 if they start 20 years later. And this is at a beyond modest investment of Rs 200 per month.
The Big Question: Stocks or Mutual Funds?
If you’re an expert and have the time to monitor stock prices and trends, stocks can prove to be rewarding. This is because the higher risk is often balanced by the high returns.
However, for those who want to reduce the risk, diversifying their portfolio is the obvious option. Mutual funds are diversified by design. They are also managed by professionals which means that we need not continually monitor them. Expert managers do the monitoring and make the decisions for us. So for a new investor who does not wish to spend too much time learning about stocks, analysing trends and so on, mutual funds can be the perfect option. Moreover, stocks being riskier can even erode one’s wealth.
Are There Any Best Practices?
It’s certainly useful to have certain goals in mind for financial planning. For those who cannot think of goals, thinking about their returns at retirement could be a good milestone to plan for. Regardless, certain widely acknowledged strategies can help us make sound financial decisions.
- Asset Allocation: While allocating assets, it is often advisable for younger investors to allocate a larger amount, say, 60 per cent or more, to equity. This is mostly because young people are still accumulating assets and may be better positioned to take risks. They also have more opportunities to grow and better their earnings.
- Assessing Your Risk Profile:How much risk is advisable for an individual? Check out this free risk survey to understand your risk profile.
- Identifying Appropriate Assets:Those who are interested in risk-aversion should be wary of long-term debt funds and should instead choose short-term debt funds. This is because short-term debt funds provide moderate returns and are also low-risk. They also have higher liquidity and help to keep things simple.
- Save First, Spend Later:Interestingly, most people operate on the principle of ‘spend first, and save the rest’. But smart people often save first and then spend the rest. Such a thought process helps incorporate financial discipline in our lives and we have a sense of how much we are spending.
- Index investments: This is because they consist of a group of investments that represent the market. This means that the returns from index investments are often the average market return. So index investments deliver market returns at very low costs. There’s also the fact that it’s not practical to predict fund manager performance for the next twenty to thirty years. In fact, even Warren Buffett agrees that index investments are the best option for retirement practically all the time
- A Long-Term Investment Perspective: This is the key to making healthy gains. Investors should pick a mutual fund and stay invested for the long run. Skipping on this crucial step often leads to missed gains while they continue to chase the very returns they may have made by staying put.
Start Young, Start Quick
Financial planning can weave magic if executed right, and help achieve long-term goals without trouble. The key is to start investing early. It makes us more disciplined and we plan out our budgets better.
Starting from a young age also gives us a lot of experience, learning opportunities and intuition which eventually factor into the decisions we make. And what highlights, even more, the importance of investing early is that even the great Warren Buffett seems to regret not starting investing even earlier.