investing, twenties, shares, share market, exchange traded funds, compound interest, compounding

The Top 3 Tips For Investing in Your Twenties

The wealth of younger Australians isn’t keeping up with the rising cost of living.

According to a recent Grattan Institute report, younger age groups have increased their wealth much more slowly than older demographics over the last ten years. In fact, the percentage of total wealth owned by people under 44 years old actually has actually gone backwards.

wealth-generation-graph

One reason for this is that the housing boom has made it harder for young people to work towards owning their own home and accumulate wealth, with home ownership rates falling the most in the younger age brackets.

According to the Australian Bureau of Statistics, first home buyers now account for just 8.1 per cent of all national housing sales, which is the lowest proportion on record and well below the long-term average of 15.4 per cent.

But despite housing affordability being at all-time lows, there are other investment opportunities outside of property that can be accessed by younger Australians, particularly shares and bonds.

And being in your twenties is actually the perfect time to start thinking about these investments; with a reasonable time horizon, diversified shares and bonds have historically offered excellent investment returns compared to leaving savings in the bank.

Here are three tips for young people looking to get started in investing.

1) Start investing sooner rather than later

Investing early means you can take advantage of compounding.

Compound returns are like double chocolate topping for your money. They not only allow your initial investment to grow, but also increase the value of re-invested profits. For example; if you earn a 9 per cent capital gains on your initial $2,000 investment in the first year and your profits are reinvested, you would then be earning returns on $2,180 in your second year (the initial $2,000 plus the 9 per cent return of $180 reinvested).

As shown in the chart below, compounding can make a huge difference to your final balance over time. Assuming 9 per cent growth per year (post-tax), the initial $2,000 investment would end up being $3,077 after 5 years, $4,735 after 10 years and $11,209 after 20 years with compounding.

And note that the steepness of the slope increases over time as your balance grows. This is what investment pioneer John Bogle describes as “The magic of compounding returns”.

When investing in shares or bonds, you can access compounding returns by re-investing the dividends and distributions you receive. When you’re young you probably won’t be relying on dividends and distributions to live off so re-investing can be a great option.

compound-interest-chart-1 * Assumes an initial amount of $2,000 at 9 per cent interest per year

Because the impact of compounding gets bigger with time, the earlier you start investing, the better the result. Investing $2,000 at 25 as opposed to 35 could double the profit you make by the time you’re 50.

compound-interest-chart-2 * Assumes an initial amount of $2,000 at 9% interest per year

And this difference would even be bigger if you make regular contributions along the way. Which brings us to our second tip.

2) Invest regularly

Putting savings aside every month will help boost your final balance, even small amounts like $100 a week.

compound-interest-chart-3 * Assumes an initial amount of $2,000 at 9 per cent interest per year

Regular investments will also help you take advantage of dollar-cost averaging to help reduce your risk. Dollar-cost averaging is a strategy to reduce the impact of volatility in the market by investing smaller amounts consistently over time. Because the markets rise and fall over short periods, it can be hard to pick the right time to buy and sell assets, so investing regularly can help balance out how much you pay for your investments.

Investing regularly is a great way to achieve goals quicker, whether you’re aiming for a new car, round-the-world holiday, deposit for a property, or wedding ring. Plus it helps you be more disciplined with spending.

3) Diversify your investments

Many people invest by just picking a few stocks. While it can be exhilarating watching your stocks go up and down, being exposed to just a few companies can put your capital at significant risk. If just one of the companies faces financial hardship or disappoints the market, a significant portion of your portfolio might be lost.

Only investing in a few shares leads to a higher risk portfolio and means you’re more likely to see big swings up and down. This can cause you to make buy or sell decisions based on emotions rather than sticking to a long-term plan.

One alternative to picking stocks is investing in managed funds or Exchange Traded Funds (ETFs). These enable you to spread the risk across hundreds or even thousands of companies so you are not overly exposed to any one business.

Managed funds and ETFs can also give you access to bonds and global shares which can provide additional diversification to your portfolio. Diversification across countries and assets is important as price falls in one country or asset class can be balanced by rises in others.

It is also worth considering ‘passive’ ETFs so that you’re not paying higher fees for ‘active management’. Keeping fees low is important as highlighted by the Stockspot Fat Cat Funds Report, which found that 78 per cent of managed funds using the S&P/ASX 200 as a benchmark underperformed the market after fees. This means that most fund managers who are paid to try and beat the market aren’t able to do so.

Therefore it can often provide a better result to simply ‘track’ the market with an indexed ETF.

fat-cat-funds-asx200

Investing in ETFs can be a great way to keep the fees low and diversify at the same time.

A single investment in an ETF gives you access to shares in thousands of companies within an index like Apple, Google, BHP, Woolworths and Westfield so you don’t have to worry about picking the wrong stock. With the right mix of a range of different ETFs, you can have a well diversified portfolio of shares, bonds and commodities to reduce risk and optimise returns.

Image: Bill Selak, Flickr