One of the key components to wealth building is to start investing as early as possible. At this point, most personal finance blogs would tell you all about compound interest and how starting early will give your portfolio more time to grow. That’s 100% true, but there is something else that’s even better. What can be better than compound interest? It’s the experience you gain from making mistakes. Read on!
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% per year, you’ll have $1,100 after one year. Your investment gains $100 in interest. The following year is even better because you’ll earn $110 in interest. You earn the interest on your initial principle AND any interest accrued. 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 more time your portfolio has to grow. 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 would have accumulated over 2 million dollars if they maxed out their 401(k) contribution since 1988 (32 years.) That’s awesome, but the problem is most people can’t max out their contribution when they first start working. Early money is the biggest contributor to the nest egg and if you don’t contribute to your 401k during the early years, your retirement funds will be quite a bit less than $2,000,000.
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 think the experience you get from investing is even more important compounding.
Experience is the key
Most of us learn best from experience. Sure, we can read and learn from books and the vast amount of resources on the internet. However, reading about it isn’t the same as going through a big stock market crash 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 that make money from commissions.
- Purchased a bunch of company stocks in my 401(k).
- Bought mutual funds based on last year’s return – chasing performance.
- I didn’t max out my 401k contribution in the first few years although I could have.
- I stopped contributing to my retirement accounts when the stock market crashed in 2000.
- 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 looked rosy at the end of 2019, but I knew there will be a bear market at some point. I have been preparing for a downturn by diversifying our asset allocation. Now, we invest in bonds, rental properties, REITs, real estate crowdfunding projects, dividend stocks, and more.
Also, I know not to sell when the market is crashing. My experience told me to buy more stocks when the market crashed down 35% in March 2020. Investors need to buy when the price is down. This sounds good in theory, but it is very difficult to execute. Nobody likes to buy an investment and see the value goes down. It’s way easier to hoard cash because it doesn’t lose value as quickly. However, my experience enabled me to overcome this fear. I knew I had to keep buying or else I’d miss the chance.
Investing is a learning process. The earlier you start investing, the more experience you’ll have. When I was young, I wouldn’t have been able to bring myself to invest when the market drops 35%. Now, I’m older and already went through 2 big stock market crashes. This time, I was ready to invest more when the market dropped. Experience helps a lot.
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 of experience under my belt. I think everyone should learn to invest young and figure out how the stock market works.
Of course, 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 a 100% gain. You don’t want to leave it on the table.
Anyway, I’m trying to teach my son about investing while he’s young. He has an investment account and it did very well in 2020. It dropped in March but came back to hit a new high recently. He can see his money growing passively and he loves that. I think it is a great lesson. He can learn more about index investing as he grows up. For now, he’s happy that his account is growing. That’s a seed, right?
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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