You work hard for your money, but does your money work hard for you?
As a young professional, it is important to invest your money and allow it to grow. With a little bit of interest and a lot of time, compound interest can work miracles for your money; otherwise, with inflation sitting at 2%, your net worth is decreasing each year if your investments are not generating at least a 2% investment return.
The world of investing can be daunting and you may not know where to start. Here are my top 5 tips:
- Compounding – The Powerful Force You Can’t Afford to Ignore
Albert Einstein famously said, “The most powerful force in the universe is compound interest.” With a little bit of interest and a lot of time, compound interest can work miracles for your money. As a young professional – time is your biggest asset when it comes to growing your money. Suppose Lisa and Mary each start with $10,000 and buy the exact same investment on the same day and plan to hold the investments for thirty years. Lisa decides to withdraw the interest each year and Mary re-invests the interest and lets it compound. Assuming a return of 5%, Lisa would have earned $15,000 in interest income while Mary would have earned $33,000. The key is to save early and use time to your advantage.
- Choose Your Investments Based on Life Goals
Your investments should reflect what your life goals are. For example: your retirement portfolio should be invested differently from the money you are setting aside for a house purchase five years from now. You can afford to take a lot more risk with your long-term investment portfolio. A good rule of thumb is letting your age determine the amount of bonds you should hold for your long-term investments. If you are twenty-five years old, you can hold 25% in bonds and 75% in equities, and if you’re thirty years old, 30% in bonds and 70% in equities. The younger you are, the more equities you should hold and the older you are, the more bonds to hold in order reduce your investment risk.
- Keep Costs Low
Investing is not free and being mindful of fees is a huge part of your investment success. Traditional mutual funds’ fees are 2.7%, while investing in an index fund can be as low as 0.33%. Here is some perspective on why this matters: Assuming a $100,000 investment portfolio, at 2.7% fees, after thirty years of growth at 7%, your portfolio will be approximately $353,000; however, the same $100,000 will be worth $893,000 with 0.33% in fees. a difference of 60% in your net worth just on fees alone. It’s crucial that you keep the investment fees low when investing.
- Diversification is crucial
Diversification is powerful because it is similar to an investment insurance for your money. Diversification reduces the risk and protects your money because we have no way of knowing which investment class will perform well and which poorly. The best way to reduce the risk would be to have your money spread across different asset classes – domestic stocks, international stocks, bonds and cash, and across different geographic locations and industries. With this strategy, a significant loss in any one investment doesn’t destroy your entire portfolio and different asset classes often move in reverse directions, hence reducing investment risk.
- Dollar Cost Averaging
Dollar cost averaging is the practice of investing a fixed amount of money every month regardless of how the investment market is doing. With this consistent investment approach, when market prices are low, your money buys more shares, and when prices are high, your money buys fewer shares. This strategy helps the investor buy more of the investments when it’s cheap and less when it’s expensive and thus reduces your exposure to risk. It is also a very disciplined approach to investing since the money gets automatically invested and you don’t need to put in time and effort to monitoring market movements on a day to day basis.
If you would like to learn more about how to save and invest as a young professional, Financial Planner and educator Stacey He hosts a monthly Money Management for Young Professionals workshop series. Details of the next workshop (on February 8th) can be found here.