I am fortunate to have the opportunity to regularly speak to college students who seem eager to secure their financial futures.
There’s an old saying that “teaching teaches the teacher,” and I always learn from this. One thing I’ve repeatedly learned is the value of reducing investment success to its fundamental elements.
College students find it easy to grasp three keys to success:
- Follow the math.
- Understand history.
- Put your savings on automatic.
Before I elaborate on those ideas, I want to share two other important points.
First, I’ve recently started talking about the difference between investing as a journey and investing as a series of events.
Most investors pay far too much attention to events that seem extremely important now, events that are all but certain to be only distant memories in a few years.
- These days, the focus is on the collapse of a few banks.
- In October 1987, the seemingly catastrophic event was a one-day loss of 22% in the S&P 500 SPX, +0.89% (which had a profitable year, by the way).
- In 2001 it was Sept. 11.
- In 2008, the big event was the collapse of the real-estate market.
These events aren’t trivial. They caused, and in some cases are now causing, plenty of pain and worry. But they don’t have much to do with the long-term journey that’s necessary to build a lifetime investment portfolio.
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That leads me to a second major point, something I’ve started telling young people: When you invest, you are essentially creating a long-term business, with many partners who work hard for you.
Throughout your investing career, you’re the senior partner, the boss.
Without doing anything extraordinary, over time you can build your business into something that’s probably worth more than many of the strip-mall businesses near where you live.
Every business starts somewhere, usually with the owner putting up some capital. About 40 years ago I started a business by putting in $ 15,000, then following up with thousands of hours of work over the years; the business, which I no longer own any part of, is now worth millions.
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A young college graduate who starts by investing $ 500 a month, or $ 6,000 a year, can immediately “hire” a group of business partners who are motivated to work tirelessly for the resulting partnership.
If you invest in an index fund (or several), you can immediately have thousands of companies, with thousands of chief executive officers and millions of employees, working for you. They are your partners.
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In the early years, what you do (specifically, the money you keep investing) will make most of the difference in the growing value of your “business.”
But after a time, what your thousands of hardworking business partners do (the stock market, in other words) will have more impact.
And yet you are always the senior partner, the controlling force. The ultimate success of your business will depend on how you manage the partnership.
This leads us back to the three “keys to success” I mentioned earlier.
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Follow the math
Despite everything you might wish or hope for, there is no escaping a basic principle of grade-school math: The sooner you start saving money, the better your results will be.
I recently spoke to about 150 Rutgers University Honor Society engineering students on this topic, and they easily grasped my message. You can too.
Simple mathematics also shows that if you can increase your annual investment return by 0.5%, you can boost your lifetime benefit by 28%.
If you double that, for an additional 1% return, the percentage increase more than doubles, to 64%.
Basic math also points to big benefits from automatically increasing your savings each year. This doesn’t rely on the market; it’s entirely the result of your commitment as the senior partner to grow the business.
Here’s the article in which those three tables first appeared: Young investors can retire rich—or super rich—by following these steps
This isn’t rocket science, just math. That was the theme of my presentation to the Rutgers engineering students.
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Understand history
This covers a lot of ground, but here are half a dozen important things history teaches us about how to run your investing business successfully.
- Not all asset classes are created equal. Small-cap stocks and value stocks over time have outperformed large-cap stocks and growth stocks.
- Diversification should be your best friend. By owning stakes in thousands of corporate enterprises, you will make sure your business won’t be ruined when one of them implodes.
- Expenses matter. Sales commissions, management fees, trading fees and taxes can easily add up to 2 percentage points of return that could otherwise be yours.
- The allure of beating the market is strong, but it’s a trap for suckers. Most investors who rely on active managers fail to achieve the returns of even simple, inexpensive index funds.
- Risk is real, and overeager investors can get in over their heads. As an investor, you deserve a piece of the action. But if you let greed imperil your peace of mind, you’ll likely be sorry.
Put your savings on automatic pilot
When you’re trying to save up for a goal that may be years or decades in the future, I guarantee that from time to time you’ll find other uses for the money you know you should be setting aside.
You may be sure you’ll be able to make up for it later, after you take care of some more pressing concern. When you do that, you won’t experience any negative near-term consequences. And your brain will likely tell you that it’s all OK.
Unfortunately, by the time you realize the full consequences, the long-term damage may be already done, with recovery all but impossible.
The solution is easy: automate your savings through your bank, your employee retirement plan or a mutual fund.
Smart young people have no trouble understanding Warren Buffett’s often-quoted advice to do your spending after you’ve done your saving, instead of the other way around.
The ones who put this into practice will likely be among the most successful investors of their generation.
You can too.
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of “We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement.” Get your free copy.