A Fighting Chance Finance

When you’re young and you haven’t earned a single paycheque yet, the concept of growing your wealth can seem quite daunting. People generally start out in their careers with the lowest paying jobs that don’t produce a lot of extra income that can be used to invest and grow wealth. So why not just “wait until my income is higher and I can invest a meaningful amount”? I’ll tell you why.

Time is more powerful than money

Let’s assume that if you did invest, you would do so in an index fund. This is the way to go when you’re young because getting proper diversification of risk is important and it can’t be done properly without tens of thousands of dollars invested into individual stocks or investments. So over the past century, the main American stock index, the S&P 500, has produced a 10% return on average. Let’s assume management expense ratios and fees on your index fund are negligible to make the math easy. In reality they are somewhere under 0.5% per year because of the passive nature of the index fund.

When you have an opportunity to invest, the most important factor is the time between when the money is invested, and when you think you will need it. Then you can determine how powerful the growth will be. Take a look at this chart below to see what I mean.

The chart says that $1,000 invested for 50 years turns into $117k! If the same person were to wait ten years before making that first deposit, when the money is needed down the line, their money would only have grown to $45k. If they wait 15 years, the money will only be able to grow to $28k. So now you can see, that even modest amounts over super long periods of time can become very substantial amounts of wealth. When you’re young and you’re thinking about buying that latest Xbox for $1,000, just know that what you’re really doing is saying “I’d rather have an Xbox now, than a new BMW in retirement”.

What to invest in

When you’re just starting out, there are a few things to consider when you’re deciding on what to invest your money in.

Risk

If you have a long time horizon, like decades and decades, then you can afford to take on more risk, because you have more time for values to recover before you need the money. If you need the money in a couple years to buy a house, its not prudent to put the money at significant risk.

Therefore, when you’re young I would recommend taking on the most risk that makes you feel comfortable and lets you sleep at night. This is going to be a decision which is very personal to each person. To me, I don’t mind taking risk on micro-cap companies which are in their initial years with a promising future with a small amount of my net worth, but I wouldn’t feel comfortable putting money into highly speculative cryptocurrencies which could lose huge percentages of their value in minutes or hours. If you aren’t sure what kind of risk tolerance you have, start with something less risky, and ratchet up risk with future contributions.

Selecting an overall index fund like the Dow, S&P 500, TSX, LSE and so forth, is the best option for most people. These index funds are usually within exchange traded funds, so you can buy and sell them very easily within an investment account. They are essentially mimicking the contents of those stock indexes and so you get exposure to hundreds of companies within the index, even though you’re only putting in a small amount of money. The fund takes all the money from all the investors and invests it in the companies that make up the index.

What you SHOULDN’T do, is go on social media and look for people who will give you tips on good stocks to invest in. Be weary of people like this, as they often have self interest in mind. A common scheme like this is called a “pump and dump”. In a pump and dump, an investor buys shares of a company at a low valuation. Then they promote the stock to pump up the share price beyond its fair value. Then, when the stock reaches a high point, the investor dumps their shares. The people who bought during the pump are left with high cost basis, and often lose money as the stock returns to a fair trading range.

I recommend reading my book, as it includes chapters on proper due diligence on a company that will give you the tools to understand whether you think the company is strong enough to deserve your investment or not.

Account type

Most countries offer their people some kind of tax advantaged investment account to help them begin growing their wealth either with no tax on gains and withdrawls, or with tax deductions for contributions made. These tax advantages are huge gifts from government that should be taken advantage of first. In Canada, that means the tax free savings account, registered retirement savings plan and registered education savings plan. To not pay taxes on gains can compound over time in a very meaningful way.

Approach

The best way to approach investing early on is to automate it. If your employer has a group RRSP plan, that is a good way to make contributions automatic because the payroll person at your company will take the contributions off of each and every paycheque before the net amount is sent to you and its taken care of. You don’t need to remember to contribute each time you get paid. In many cases the employer will even match the contributions you make, giving you an immediate return on your investment before you even invest the money! Getting money for free is always a good thing! The plan will usually have a selection of investments to chose from. Again, I’d recommend taking on as much risk early on as you feel comfortable with, because more risk means higher returns generally and you want to get that compounding snowball rolling.

Overall

Just get started. Use that time you have to your advantage! You might make some mistakes early on, but that’s ok. Just get started and you’ll learn as you go. Even when the amounts seem small to begin with, remember that in 50 years they will be over 100 times larger than they are now by investing in a simple boring exchange traded fund!