Ask a seasoned Australian investor, and they will have little doubt about why they put their money to work. They’re thinking about retirement, paying off homes and giving their kids a financial boost, building great businesses – building wealth.
But when it comes to younger Australians, it’s more challenging to encourage them to start making smart investment choices. The vast majority don’t invest at all, with many saying they can’t afford it or simply don’t know enough.
Millennials are facing uncertain economic times: wages are stagnant, job security is low, retirement ages are blowing out, living expenses are high, and the wealth gap between the rich and the rest is only getting wider.
But think about it another way: everything cited above is actually a great reason for young Australians to invest. Sure, young people may believe they don’t have the wealth, experience and wisdom possessed by those older than them, but they do have that most golden of investment assets on their side – time.
In a nutshell, young Australians should not only be investing, they should be the most successful investors of all. But to make the most of that time advantage, Millennials do need to dodge six of the most common mistakes made by young investors.
What are they?
Waiting too long
As we’ve mentioned, the huge investing advantage possessed by the young is time.
While just paying the rent (let alone saving for a house deposit) can be tough, the compounding gains of getting in early on risk managed, long-term investments will more than pay back the young investor later in life.
In fact, Albert Einstein said compounding interest is so spectacular that it’s actually the “eighth wonder of the world” – because all it requires is constant reinvestment and the magic of time.
But wait too long, and the young investor will already have made their first crucial mistake.
Balking at the risk
The main reason young investors miss that crucial early investing window is because they don’t think they have the smarts or the experience to make it work.
Many young people think of investing as too risky. Smart investing is about considering both sides of the equation – the potential risk and potential return. Good investment advisors consider their client’s tolerance for risk and create appropriate portfolios.
In Clover’s case, our recommended portfolios vary from conservative (80% bonds, 20% shares) to aggressive (10% bonds, 90% shares), and include a minimum recommended investment timeframe. Essentially, the more aggressive your risk appetite is, longer the minimum recommended timeframe for the investment.
Longer timeframes give you the best chance to recover from sharp market declines such as the Global Financial Crisis.
Gambling rather than investing
Another big mistake commonly made is confusing investing with speculating. While a diversified portfolio tailored to your risk profile is smart investing, speculating is closer to gambling than to investing.
Investing is based on careful analysis of risk vs potential return and tends to have a direct link to underlying business or economic activity.
Speculation typically involves buying something with a hope that somebody else will be willing to buy it at a higher price in the near future. The difference between investing and speculation isn’t black and white. For example, buying a stock after careful analysis of the longer term earnings prospects of the company and its valuation would be considered investing.
Buying the same stock at 10am with a view to sell it at a higher price at 11am is speculation.
Chasing ‘hot’ stocks
Often, a young Australian will be enticed into the world of investing because they have a confident friend who insists it’s a great way to build wealth.
And, while a recommendation about the benefits of investing is right, it’s not a great idea to just do what your mate is doing or what is trending on Twitter.
The surging popularity of bitcoin is a great example of this.
Don’t let the fear of missing out influence you to make risky decisions, especially when you do not understand it.
Warren Buffett himself put it best when he said:
“By periodically investing in an index fund, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb….Those index funds that are very low cost….are investor-friendly by definition and are the best selection for most of those who wish to own equities.”
He even challenged hedge fund managers to a one million dollar bet that low-cost index funds would produce superior outcomes for most investors.
Thinking cash saving is better than investing
Warren Buffett also said:
“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.”
At first glance, it might appear that high interest savings accounts are an easy way to make “free” money. But is this really true? When you account for inflation and tax, you’ll see that the rate of return is much smaller than you’d think.
If you want your money to work for you over the longer term, investing in assets such as shares and bonds is key.
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Also published on Medium.