People delay making financial decisions for lots of reasons: lack of time, financial knowledge, or money to invest are all common ones. And as research shows, people are a little too good at putting off difficult tasks and letting their “future selves” deal with them. (Unfortunately, the same research shows that our future selves are no better at tackling those tasks.)
It feels hard to take the first step -- but having a good long-term investment plan can make it much easier! And acting now, rather than decades from now, will give compound interest more time to grow your wealth on your behalf. Let’s dive into a couple examples…
You Don’t Need to Pick Stocks (or Know Much About Markets at All...)
Never mind Jim Cramer -- research shows that frequent trading undermines performance. Doing less is better than doing more. Sounds easy, right? As Bill Schultheis writes in The Coffeehouse Investor, a large share of American millionaires follow the “less is more” strategy. In fact, 42 percent of those millionaires buy or sell securities less than one time per year.
The key to this approach is having a solid investment plan at the outset, and sticking with it over time. A good wealth manager will help build you a well-diversified portfolio based on solid evidence and theory, and then rebalance it as markets shift. Rebalancing is all about diversifying your risks, rather than trying to time the market. No one has a crystal ball to predict the market, which is another ding against stock-picking -- most of the professional “experts” make choices that perform worse than chance.
Smart financial management is actually easier than many people expect. And the smartest move is to put time on your side by starting now.
Time Heals All Wounds, and Maximizes Your Earnings
We’ve all heard it: compound interest works magic. But just how powerful is it? Imagine two investors who each have 30 years to save. If one of them invests X amount every month for the first 10 years and then never puts in another penny, that would generate the same amount of wealth as staying out of the market for the first 10 years, and then investing the X amount every month for the last 20 years. That is, 10 years of investing is worth twice as much early in your life as it is later on.
Check out the chart below -- Sara starts investing early, but stops after a decade, while Bo waits 10 years to get started (and has to invest for twice as long to catch up!)
Of course, for the best results of all, Sara should keep investing. Below, we return to our examples of Sara and Bo, but with Sara investing continually over 30 years:
Now let’s look at the flipside of compound interest, which is compound fees.
Fees consume a substantial cut of your returns, and those losses work against your portfolio tirelessly for years. It so happens that fund fees are the best predictor of performance -- but not how you think! Funds with lower fees actually perform better. So don’t let your wealth get eaten away in funds that charge too much and underperform!
Of course, the most powerful strategy combines all of the above: start early, cut fees, and invest for the long term (e.g. don’t chase short-term gains).
This three-pronged attack really adds up, increasing returns and decreasing the time it takes to double your money.
Even if you don’t have 30 years to run, starting to craft a long-term, low-fee investment plan NOW is much better than starting next year.
Need some help getting yourself geared up to take the plunge? Stay tuned next week, as we’ll write about the intriguing topics of behavioral economics, psychology, and decision-making.