Three Essential Lessons for Young Investors
Young investors have the advantage of a long time horizon and no preconceived ideas of how to invest. Three essential lessons can help them become successful investors.
Menlo Park, CA (PRWEB) March 9, 2006 -- Learning how to invest properly at a young age is extremely valuable. Parents, or thier financial advisors, can help their kids tremendously by providing sensible investment education and guidance before they have a chance to make mistakes.
"I occasionally have the pleasure of providing investment and financial planning advice to the adult children of my clients," says Dan Goldie, a financial advisor to wealthy individuals and families in Menlo Park, California. "I have also given investment workshops for Stanford University’s graduating senior class. It is rewarding for me to help new investors learn how markets work and how to make smart financial decisions. Frankly, it is the best time to learn about financial matters."
There are three essential elements of a well-conceived investment plan.
–Think long term
–Stay diversified
–Avoid mistakes
Think Long Term Investment success should be measured in decades, not years or quarters. According to Mr. Goldie, "In many ways, I believe the financial industry’s standard of reporting portfolio performance quarterly, and delivering brokerage statements monthly, works against the long-term interests of investors. After all, it is only with consistent, long-term success that significant financial goals are realized."
For most investors, staying focused on the long run is challenging. There is plenty of noise and distraction vying for your attention, which makes it easy to get sidetracked. Some of the confusion is caused by Wall Street hoping to get your business by playing to your hopes or fears, or by news publications trying to get catch your eye. Other noise is generated by the very nature of financial markets themselves, and the vast amount of information all around us. Now, more than ever, it is difficult to stay the course.
All this commotion can cause an investor’s attention to be misdirected. It is not the day-to-day fluctuations of markets that should concern you. The primary risk you face as an investor is the constant threat of inflation eating away at the purchasing power of your assets. For example, at just 3% per year, inflation will reduce the purchasing power of a portfolio by one-third after 14 years, and one-half after only 23 years. Your most important task is to invest your assets to protect yourself from this erosion.
"A successful, long-term investor knows there is a difference between comfort and safety," continues Mr. Goldie. A comfortable portfolio does not fluctuate much in value. It might be invested in fixed income securities with an expected return not much more than the rate of inflation. In contrast, a safe portfolio would have expected returns well above inflation. It would be invested predominately in stocks and highly diversified. This portfolio will fluctuate with market movements and not always be comfortable—during stock market declines, for example—but it will provide for long-run inflation protection.
Stay Diversified
The stock market is not a zero-sum game. There are not winners and losers in these markets, with the winners taking all the spoils and the losers going broke. Mr. Goldie says, "Capitalism generates positive returns overall, and, although some win more than others, everyone can win. The elegant truth of economics is that the return on capital is exactly equal to the cost of capital. In other words, in the aggregate, the return to investors is equal to the payment required of those entities, such as governments and corporations, seeking to attract investment capital."
Wealth is created when natural resources, labor, intellectual capital and financial capital combine to produce economic growth. As an investor, you are entitled to a share of that economic growth when your financial assets are invested in and used by the global economy. This is not a free lunch. It is your fair share of profits as compensation for putting your money to work.
Mr. Goldie follows by saying, "One of your main goals should be to capture as much of the global return on capital as you can. I believe the most reliable way to accomplish this is to be fully diversified in many asset classes around the world. You want to efficiently capture specific risk dimensions, and the associated returns, of the global capital market while minimizing friction costs, such as trading expenses and tax costs."
Diversification can also help reduce portfolio volatility. If the securities in your portfolio do not move in tandem with each other, the offsetting price movement can reduce overall volatility. This is an important part of building wealth because reduced downside movement results in increased compounding and greater ending wealth accumulation, all else equal.
Avoid Mistakes
Errors dominate the investment world. The preponderance of successful investors did not grow their wealth because of brilliant decisions; they grew it by avoiding mistakes. Financial blunders can be costly to those who choose to learn the hard way. According to Mr. Goldie, "The market is a great teacher, but it charges a steep tuition."
Errors are best avoided by maintaining a disciplined approach. But discipline is elusive and it is easy to understand why. Volatile markets seem to offer many apparent opportunities to buy low and sell high, and there is no shortage of brokerage firms and others offering to help you try your luck.
What they don’t tell you is that markets work and that there is little evidence that stock picking or market timing beats market returns. This approach, and all others that rely on forecasting or concentrated betting, is speculating, not investing. Investing involves putting your money to work in the capital markets in an efficient manner so as to capture, as reliably as possible, the return on capital delivered by the economic system.
Do this for the long haul and you will be a successful investor. Teach it to your kids and you will have given them a great financial gift.
Dan Goldie is an independent financial advisor to individuals and families. He is located in Menlo Park, California. Investment Advisory services provided through Partnervest Advisory Services LLC.
