You are here
Investment advice I wish I knew when I was 25 years old
TIME is an investor's best friend. The variable that has the biggest impact on an investor's long-term return is the time invested. The longer the time, the more compounding of returns.
This article will give in one page the most important lessons I've learned from almost three decades of investing. It is aimed especially at young people starting their career and earning their first paychecks, so that they can become financially secure into middle age and beyond.
The most critical point is starting early (Lesson 1, below). The second most critical is avoiding critical mistakes and investing correctly for the long-term (Lesson 3). Making mistakes that cost you money has the same effect as starting to compound your investments later in life.
Lesson 1: Understand investment compounding (and reverse compounding)
By far the most important contributor to your end wealth is the length of time you've been investing. Use your very first monthly salary to take your parents out to a nice dinner, to thank them for all the work they've done in raising you. Start saving early and investing from your second months' salary.
Imagine Investor A (let's call him Aiden), and Investor B (Bryan), both are the same age. Aiden starts to save $1,000 a year at age 25, and does so for 10 years. At age 35 he stops adding any money to his investment portfolio, having contributed a total of $10,000.
Bryan instead spends all his monthly earnings in his youth. After hitting middle age, he takes a look at his zero balance bank account, and decides to start an investment portfolio at the age of 42. He saves $5,000 per year, and keeps adding $5,000 every year until retirement, contributing over $100,000.
If you compound Aiden's and Bryan's portfolios at long-term equity returns, at retirement Bryan's portfolio will still be worth less than Aiden's, despite having contributed more than 10x from his salary.
This stark difference in results is just from a 17-year head-start. You want to be like Aiden, not Bryan. Even better, be Investor C (Cherine). Cherine increases her savings contribution to her investment portfolio every year as her career progresses, instead of keeping it static. In addition to increasing the investment compounding, doing this has the added benefit of reducing the negative impact of any equity bear market in the initial years of investing.
Einstein supposedly called compound interest the eighth wonder of the world. Humans have difficulty visualising the impact of compounding an investment over five decades.
The opposite of compound interest, such as paying interest on a loan, has the exact same long-term effect but in reverse, with disastrous consequences for accumulating long-term wealth.
Lesson 2: Do not take a loan to buy a car (or any other depreciating asset) early in your career.
Paying compound loan interest works against you exponentially. Taking a loan to buy real estate is better, since it is not a depreciating asset. However keep in mind that real estate requires additional capital (property taxes, renovation costs, mortgage interest, etc, all of which compound negatively), costs that investors rarely take into account when calculating their return.
Lesson 3: Invest properly
The next important lesson is to invest the right way. In analysing and testing many strategies in my personal accounts, I've probably made every error an investor can possibly make, even mortgaging my first apartment to have capital to start a speculative trading account.
Lesson 4: Don't ever do this!
I have watched many of my mistakes, such as being leveraged long into a bubble peak, as well as becoming leveraged long too early in a downturn, repeated by investors over and over again. Avoiding these errors will give you a big head start.
Successful investing over five decades is not about finding undiscovered stocks (or the next crypto investment) that goes up one million per cent. Hendrik Bessembinder a professor from Arizona State University wrote a fascinating research article in 2017. I have read it multiple times looking for flaws in its argument, but did not find any. It concluded that less than 4 per cent of all stocks in history contributed to all of the historical performance of the stock market. More surprisingly, 58 per cent of all stocks in history underperformed cash!
This research goes a long way to explain the struggle that active investors face in outperforming an index. But there's good news, these days you can simply invest in the index.
There is a possibility that you'll outperform the markets by trading. You might even be one of the few that can do so consistently over time. Or you might find a friend else that will achieve this for you. But Prof Bessembinder's research shows that the odds are massively stacked against you. I have spent decades devising trading systems that outperform, as well as investing with other managers who are targeting the same result. It has been a long, painful, and costly journey. If you plan to trade stocks yourself, do not expect success unless you devote yourself full-time to this pursuit. Even then, this endeavour will probably set you back at least a decade in compounding your investments, as you re-learn all the costly lessons that good traders go through in their journey.
In your investment life, do not be tempted by returns that are too good to be true, or by fund managers who seem to turn everything they touch into gold. I have seen my fair share of them, and they all come crashing back to earth. Good traders know that generating alpha is a constant struggle, and they respect the risks in trading financial markets.
I blew up (defined as a loss of more than -95 per cent, from which your portfolio will never recover) my personal trading account twice while testing strategies, before I finally fully respected the risk of leverage. I count my lucky stars that I only mortgaged my apartment (Lesson 1 above) for a trading portfolio after these two ruinous events. You want an investment manager who has learned these hard lessons with his own capital, instead of making such a mistake with yours.
And finally, Lesson 5: You can't control the short-term returns.
Focus instead on what you can control. You can control your trading costs (keep them as low as possible). And instead of constantly monitoring your investments' short term performance, keep a frequent eye on the strength of the financial institution which custodises your investments. In 2008 the financial system came near collapse, and many brokers and banks failed. If you're now 25 years old, I'll lay a wager that you will go through at least one such similar event in your investing lifetime, and possibly even two. Be well prepared.
- The writer is co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund-management services to endowments and family offices, and wealth-advisory services.