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Why you need to start investing when you’re young

by retirebyforty on June 12, 2013 · 48 comments

in investing

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One of the key ingredients to building wealth is to start as early as possible. At this point, most blogs will tell you all about compound interest and how starting early will give your money more time to grow. That’s true, but lately, I’ve been thinking there is something else about starting young that gives you even more advantage than compound interest.

The power of compounding

Let’s go over compound interest quickly first. Compound interest is awesome. Everyone loves compound interest and it’s easy to see why. If you invest $1,000 and gain 10% interest per year, you’ll have $1,100 after one year. The investment earns $100 in interest over the one year period. The following year is even better because you’ll earn the $110 in interest. You earn the interest on your initial principle AND any interest you accrued so far. Every year you will earn more and more interest. See, what’s not to love?

You can easily see that the earlier you start investing, the longer you will be in the game. Time is the secret ingredient in compounding. The more time you have to invest, the wealthier you will be.

What’s more important than compound interest?

When finance bloggers talk about compound interest, they usually make some unrealistic assumptions. In What if you always maxed out your 401(k), I showed that an investor could have accumulated $727,518 if they maxed out their 401(k) contribution since 1988 (25 years.) That’s awesome, but the problem is most people can’t (or won’t) max out their contribution when they first start working. Early money is the biggest contributor to the nest egg and if you contribute lightly during the early years, your retirement funds will be quite a bit lighter than $747,518.

I’m just saying most people can’t save much when they are young, so compounding may not be the most important factor contributing to wealth. Lately, I’ve been thinking that the experience you get from investing is even more important compounding.

Experience is key

Most of us learn best from experience. Sure, we can read and learn from books and the vast amount of material on the internet. However, it’s not the same as going through various situations personally. I started investing when I got my first full time job at 22. Like any new investors, I flailed around for a few years and made many mistakes. Here are just some of them.

  • Invested with my bank’s financial advisors. I didn’t know they were just glorified salesmen out to make commissions.
  • Purchased a bunch of company stocks in my 401(k).
  • Bought mutual funds based on last year’s return – chasing performance.
  • Didn’t max out my 401k contribution in the first few years although I could have.
  • Didn’t know much about asset allocation or diversification.

These days, there is so much more information on the internet and young investors should have an easier time avoiding these pitfalls. However, the learning experience from my mistakes was invaluable and I knew more and more with every stock market cycle the stock market.

why start investing young

The stock market looks rosy now, but now I know there will be a bear market in the future. I’m preparing for that by diversifying into more bonds and other investments. It’s a learning process and we can all get better the longer we invest. I’m not saying that I’m a better investor than other young folks. I’m just saying that I’m a lot smarter now than I was in 1996.

Start investing as young as you can

I wish I knew more about the stock market when I was in high school or college. That way I could have had 5 or 6 additional years under my belt. I think everyone should learn to invest young and figure out how the stock market works.

Of course, as alluded to earlier, many young folks don’t have any money to invest. These days, new graduates have a ton of student loans to deal with, too. I still think it is very important to start investing even if you have debt. The easiest thing to do when starting out is to contribute to your 401(k) at least enough to get all the company matching. That’s 100% gain which you don’t want to leave on the table.

Contributing to the 401(k) is a great way to start, but investing in the retirement plan usually is limited to mutual funds. They are great when you are a beginner, but you need to learn about individual stocks too.

As a parent, I will encourage our kid to start investing as soon as he can understand the concept. I’m sure it will start out very small with $50 from his grandparents or something like that. He can put it into an index fund and later on I’ll teach him how the stock market works through virtual trades. I can’t wait until he’s old enough! Maybe when he is 14 or so?

When did you start investing in the stock market? Do you think you could have done better if you started earlier? 

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{ 45 comments… read them below or add one }

The Dividend Guy June 12, 2013 at 2:40 am

Hey Joe!

I would add two other points:

#1 Investing mistakes at a young age are not too bad.
I’ve made some mistakes in my 20′s with small amount and it was a good thing I made them back then. I’ve once lost 50% of my portfolio (which was $5,000 back then) on a bad trade. I never repeated that mistake again. However, if I had lost the same 50% at the age of 45-50 (like people who invested in Nortel a few years ago), I would have lost over 100K. It’s good to learn investing with small amount at a young age :-)

#2 You can take more risk
As I said, losing money when you are in your 20′s isn’t that bad since you have several years ahead. You can then take more risk and hope for higher return. I’ve bought my first house at the age of 26 with a cash down coming from my trading profit. I would have never been able to buy a house without investing.

Great post!

Mike

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Pretired Nick June 12, 2013 at 12:34 pm

Those are two astute additions, Mike. The learning Joe mentions plus these factors should take away any reason not to start early. I wish there was a way to convince more young people to dip their toes in earlier!

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retirebyforty June 12, 2013 at 11:12 pm

Great points. You’re right about losing 50%. It would be devastating for us to lose that much. It’ll set us back many years.

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Jane Savers @ Solving The Money Puzzle June 12, 2013 at 3:08 am

I started last year at 48 and bought my first stocks. Too late for me to really enjoy the benefits of compound interest and reinvesting dividends but sometimes that is just how life goes.

I will keep plowing money in to my stocks and stock based mutual funds until 3 to 5 years before I plan to retire then I will shuffle money in to less volatile things like GIC ladders.

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retirebyforty June 12, 2013 at 11:13 pm

At least you are investing now. We live a lot longer these days so I’m sure you’ll see some compound interest later. :)

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Marna June 12, 2013 at 3:50 am

My grandfather gave me $250 in a mutual fund when I was a teenager. He was an accountant. I followed that fund for decades before finally selling it. Then when my son was in his 20′s, I gave him $2000 for his first IRA contribution, along with a chart showing him the effects of compounding, and he started his own contributions through a salary deduction the following year. Then I went to graduate school so that I could learn to manage money. I make PLENTY of mistakes, but each one is a learning experience. I have 4 grandchildren now, and all the checks I write go into a 529 plan, but I hope to teach them a thing or two when they are in their teens.

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retirebyforty June 12, 2013 at 11:14 pm

Thanks for sharing your story! Great to hear about someone else’s experience.

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Your Daily Finance June 12, 2013 at 5:13 am

When you are young you are learning and you can invest less and still be on top. People who wait until they are 35-40 have to almost triple the invest amount compare to a person who started 10 years earlier.

@ Jane – Its never to late! Better to start late then never at all.

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The Stoic June 12, 2013 at 6:40 am

Solid advice. I would give anything to go back in time and tell my younger self to get his act together.

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JC @ Passive-Income-Pursuit June 12, 2013 at 7:14 am

My plan if/when we have kids is to get them invested as early as they start receiving money and while the bulk will be in index funds I think a good way to get them interested is to purchase stock in companies that they are familiar with. Think DIS, MAT, HAS, TGT, WMT, MCD, YUM….something along those lines. DIS is number one on my list though to try and get their attention.

I also with I had known more about the stock market and investing when I was in high school. I feel that those were wasted years as far as compounding. The other great thing about starting as early as possible is that it not only teaches the concept of investing to have a larger amount but also the discipline to continue saving later on.

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retirebyforty June 12, 2013 at 11:15 pm

That’s a great strategy. I’ll teach my kids about investing in good companies that we are familiar with too.

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Mike@WeOnlyDoThisOnce June 12, 2013 at 7:17 am

The impact of compound interest poses some difficult questions: would you still drink that $2 coffee, knowing that putting away those two bucks could equal close to a grand with compound interest?

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retirebyforty June 12, 2013 at 9:57 pm

Yeah, that’s why I hate buying coffee. I only do it for the social aspect and sure I think it’s worth it then.

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Paul @ The Frugal Toad June 12, 2013 at 7:21 am

I started right out of college with a company sponsored 401k plan. My employer matched the first 6% dollar for dollar. Time value of money is truly a powerful thing!

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retirebyforty June 12, 2013 at 9:57 pm

I love matching!

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John S @ Frugal Rules June 12, 2013 at 7:25 am

I totally wish that I would’ve started investing earlier. Those are years I can’t make up for, but I can only move on now. I think that many allow the fear or the fact that they have little to invest hold them back. I say even if you’re starting with a small amount it is better than nothing so you can start to develop that discipline of long term investing.

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Jamie June 12, 2013 at 7:26 am

I started ‘seriously’ investing in the market when I got hired here at my current job and had the option to have a 401(K). I can afford to put in the 4% that will get the company 100% match. When I was 18 or 19, I opened a ROTH IRA (so, 7-8 years ago) and I was not aware that my money was put into a money market. I’ve probably accrued a total of about $10 over that time (again, 7-8 years) because I could only put in $50 each month. I wish wish wish someone had said, “open it at Vanguard in mutual funds, not at the bank in a money market!” I try really hard to not regret that, because I could have so much more of a return at this point. Lesson is definitely learned, and boy will I not forget it. (Speaking of, are there even any good points to having money in a money market Roth IRA fund when you are 18 years old and can only contribute 50 a month? Was the banker/seller thinking there was another advantage to this that I am just plain not seeing?? I wonder.)

I’m moving this Roth money over to State Farm with my agent soon, which has expense ratios and fees, but, I also want someone who is smarter than me keeping an eye on my money. I don’t really trust myself to manage my ‘for real’ retirement savings anymore so I’m willing to pay more for someone to help me out with it. Ugh. I was thinking on the right track starting at the right age and got screwed anyway!

I’d like to open an account at Vanguard to play around in, but I could still only maybe put in another 50 each month, with maybe 500 for the opening balance, and I don’t think they offer anything that has that low of a minimum, so I’m stuck in my savings account getting a terrible rate there. But it is a goal within the next few years (let’s say by the time I’m 30, so, 4-ish years) to get something started at Vanguard!

I’m really enjoying reading your blog. It makes me think a lot, is very resourceful, and gives me hope for my financial future and goals.

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retirebyforty June 12, 2013 at 10:02 pm

Sorry to hear about your money market experience. At least they didn’t try to sell some expensive mutual funds. I don’t see any advantage to it at all.
Why don’t you move the Roth money to Vanguard now instead of state farm? You’ll learn a lot from managing your own account.
You can start with index funds and keep building from there.
Good luck!

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Jamie June 13, 2013 at 5:53 am

That is a really good point: I’m glad that as in-experienced as I was, they didn’t try to take advantage of me. (I’m sure it helped at the time that I had 2 extended family members working at the branch watching over me, thank goodness!) I chose to go with State Farm because my boyfriend & I have a good history with the agent. There has been no pressure to “sell sell sell!” us anything, and I feel like he’s going to be one of our most important resources for eventually branching out into other investment options, including real-estate (to rent out), peer-to-peer lending (I think – it sounds very similar to what you’ve discussed), starting our own business (hopefully within the next few years), buying land to rent for farming, among other options that I can’t recall at the moment. I would feel comfortable with him knowing all our financial plans, at least initially, and his willingness to stick with us and not be ‘just another agent’, if that makes sense? Plus there’s my early retirement to think of, of course. I think we are fortunate to have him to learn from, and I really want to squeeze as much as I can out of it!

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mayanqueen July 15, 2013 at 2:39 pm

Jamie, you are not alone in that “naive” boat. One really need to have knowledge to invest. Not everything that has the name “Vanguard” is good. About 25 years ago my husband and I invested $7,000 in who knows what by Vanguard. Before we knew the account in less then a year was worth less then $2,000. Who knows what happened and just think that 25 years ago everybody was speaking highly about Vanguard and still do. I just ran away when I hear anything about Vanguard. That is because the bad experience we had without having the knowledge at such a young age. Imagine how long it took us to save $7,000. Since then I only invest in what feels safe. I do invest a bit on 401K, but not much. Somehow I am one of those that prefers have access to money quick and not until retirement. There is a retirement fund at work which is mandatory. After the Vanguard experience I turned out skeptical and invested on CDs only. Imagine CD during that time were paying 10% in credit unions. But I liked that the money was available in short terms. Those were the good old days. I always had 3 CDs for 12,24 and 36 months constantly rotating. That way I always had a CD maturing each year.
Now besides paying off our home I don’t know what else to do without guidance. I don’t want to invest in those investments in which your money is tied up! or in which you have access until you are ready to die!
My friend retired about 3 years ago and died of cancer last week! I know I will live longer because my grandma died at 99 and her sister is 101 years old! Still, when I see friends dying young, it makes me think twice about having my money locked! So, you are right when you say that paying someone to keep an eye on your money is a good choice! Am I gonna change my mind about Vanguard, probably not. I called the Vanguard directly when we did our first investment, I somehow believe that Vanguard should have given us better “guidance”.

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Andrew June 12, 2013 at 7:37 am

I’m lucky that my dad was knowledgeable about investing and taught me about mutual funds/IRAs/stocks. However, I first started investing in 2002 a month before the internet bubble burst so I started off with a very negative view of the stock market. That didn’t deter me though.

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Kurt @ Money Counselor June 12, 2013 at 7:44 am

My advice to people just starting their working life would be, yes, start investing early for sure, but look mainly (not exclusively) for alternatives to equity investing. Look for investments where you have some control over how the investment performs–like maybe investing in yourself with additional training or education to get the return of higher income, or investing in local real estate, or perhaps starting a small side business. Sure, these have risks too, as all investments do. But to a much greater degree (vs. stock investing) you have the power to leverage your own talents and drive to help make the investment pay off.

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retirebyforty June 12, 2013 at 11:06 pm

That’s a great advice. Training and investing in yourself is always a good investment.

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Savvy Financial Latina June 12, 2013 at 7:45 am

I’m hoping in a year I can start investing in individual stocks to try to learn more and increase our wealth.

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David @my2centopinion June 12, 2013 at 9:22 am

I really like the point you made that people should be investing a least a little, even if they have debt. Getting into the habit of saving can be difficult and if you can get just a few bucks in an investment account regularly, you’ll transition to big bucks more easily.

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retirebyforty June 12, 2013 at 11:07 pm

Thanks. You have to start out somewhere, right.

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Sean @ One Smart Dollar June 12, 2013 at 10:25 am

I started investing when I got my first real job paycheck. I opened my IRA and also put money into a trading account.

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kathleen June 12, 2013 at 10:45 am

Should the recent college grad with a 7% interest student loan really be investing, though?

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Travis June 12, 2013 at 11:19 am

My order of investment/payoff priority would go:

- Company 401k match (guaranteed 100% return)
- Repay 7% loans (guaranteed 7% return)
- Invest in Roth IRA
- Invest in non-retirement account
- Repay 3.4% loans (guaranteed 3.4% return)

If my company didn’t have a 401k, I would be shoveling all my extra money into the loan repayment. First, it is a good return on the money. Second, it would be a huge stress relief to have the loan paid off.

The last two would be a toss-up. Instead of using extra money to invest in an 80/20 split on stocks/bonds, perhaps my extra money would be split with 80% stocks (VTSAX) and 20% extra loan payoff. That way the “bond” portion is a guaranteed 3.4% return.

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mayanqueen June 12, 2013 at 6:51 pm

Yes, you should invest small because of the compound interests that you will earn. It is not that much now but things are getting sort of better. If you invest before you are taxed, that is when you get the most of it! Start with small amounts and increase it little by little. If you don’t have a job yet, then forget it! Pay your loan first! If you do have a job then make larger payments to your loan to finish faster.

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retirebyforty June 12, 2013 at 11:08 pm

Maybe just a little bit to get familiar with the concept. If you wait too long, then it gets harder to invest. That’s probably why many people let financial advisors invest their money.

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Lisa E. @ Lisa Vs. The Loans June 12, 2013 at 2:05 pm

Great way to look at it. Although compound interest is a great reason to start, experience is just as important!

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Nick @ ayoungpro.com June 12, 2013 at 2:27 pm

I couldn’t agree with you more Joe. I remember seeing graphs like that early in my 20s and being blown away. I’m so glad I have a long investing time frame! :)

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krantcents June 12, 2013 at 2:33 pm

I started investing in my 20s, but really started pouring significant money into income property in y early thirties. Time is the most important part of investing because it makes up for any mistakes, volatility or bear markets.

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Anton Ivanov June 12, 2013 at 4:44 pm

Timeless advice! I was fortunate to have started investing when I was 19 and I’m so glad I realized the importance of it that early in life.

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Leigh June 12, 2013 at 7:45 pm

I didn’t start investing in the stock market until I opened a 401(k) after I started working my first post-college job. A bit over three years later and turning 25 this year, my 401(k) balance is now almost $60,000 and growing. The first year working, I only put enough in to get the match and I started maxing it out my second year. This could mean that I no longer need to contribute to my 401(k) past age 28, thanks to compounding interest.

A friend read a study on what age you should put your kids in school. Apparently the real kicker isn’t social growth or such, but the compound interest on their career growth that they lose out on.

I did put some money in retirement accounts while in college from my earned income during internships, but I didn’t invest it in stocks. I decided it was more important to concentrate on school at that time instead of worrying about how to grow my money. I think that was the right decision.

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mayanqueen July 15, 2013 at 2:59 pm

Leigh, what do you mean when you say that “no longer need to contribute to my 401(k) past age 28…”?

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Rich Uncle EL June 13, 2013 at 6:28 am

Great Post Joe,

Young Adults from experience just want to party. When I went in to a Merrill Lynch Office to invest at 19 into stocks the advisor look at me like I had two heads. Well I was lucky that he told me to invest in a Roth IRA instead, either he wanted me to have less risk or he was making a commission selling that mutual fund. Either way it has been a good learning experience.

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Think Rich. Be Free. June 13, 2013 at 7:12 am

I’m just a college student now and I’m currently preparing to try the world of investing after I turn 18 and accumulated enough money. This post made me realized how lucky am I and taught me some valuable lessons too. Thanks!

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Michael June 13, 2013 at 6:59 pm

I first learned about the stock market back in 8th grade in a class at school. It was a competition to build the best portfolio with fictional funds. I’ll admit that I did not even come close to winning, but ever since then I was hooked. I started reading other books on investing and by the time I finished high school, I started putting money in an Etrade account.

Like you Joe, my first few investments ended with failure, and a few expletives as well! I started learning more until I developed my own trading and investing strategies that I have been using and continuously developing to this very day. Like you said, successful investing takes time and the younger you start the better off you will be. I’m 27 and if I keep at it, maybe I’ll be able to retire by 40!

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thepotatohead June 14, 2013 at 4:37 pm

I’m glad I started investing at a young age. I’ve made some pretty big mistakes in the stock market, so I’m glad I was able to learn those lessons early while my nest egg is small, rather then messing up later when I have a big balance. Some expensive lessons but well worth it.

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Hannah June 19, 2013 at 3:22 am

Great post, you hit it right on the nail. Most people can’t save a lot in the early years of joining the workforce. I’m fortunate to have a good financial advisor who has helped me build my investment portfolio and nurture retirement savings.

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Diane C June 30, 2013 at 7:50 pm

Every nutjob who throws every penny into prepaying his/her mortgage without fully funding all available retirement options should be forced to buy Joe an expensive cup of coffee so he can ‘splain the error of their ways to them. Mortgages are cheap, compound interest is sheer magic.

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Jon July 12, 2013 at 11:11 am

I first started investing at 30. That was only my second full time job and the first time I had a job that offered a matching 401k. Due to job issues since then (2 lengthy unemployment stints due to layoffs) I haven’t been able to invest consistently.

My job now doesn’t offer matching on the 401k so I’m putting my money in a Roth IRA and I’m buying up commission free ETF’s. Once I have enough money in there I’ll move it to one of the Vanguard index funds that track the s&p 500. I’m not comfortable buying individual stocks at this point.

I’m also trying to build up savings for an emergency fund and much needed home repairs.

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retirebyforty July 12, 2013 at 11:40 pm

Great job with the Roth IRA. Keep investing and you’ll get more comfortable with the stock market. Good luck!

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