Greetings, teenage self. You’ve done a good job working hard and earning money, and I’m glad you want to put the money to work for you. Here are four key principles of investing:
1. Invest. This seems obvious, but as a friend of mine says, the best predictor of your retirement portfolio’s performance is that you have a retirement portfolio. If you’ll “get around to it,” you’ll never get around to it.
2. Start young. Einstein is rumored to have called compound interest “the most powerful force in the universe” (this, sadly, is almost certainly apocryphal). Imagine that you invest $1000 today, and it earns 8% per year. Next year, you have $1080. The year after, you have $1166.44. The year after, you have $1259.71. After fifty years—roughly when you hit retirement age, if you start at age 17—you have almost $47,000.
3. Diversify. Take that money you’re planning to invest on a couple of “hot stock tips.” Don’t buy those two stocks that you think are so great. Instead, put the $1500 you lost on those stocks in an S&P 500 index fund through a Roth IRA or something similar. They didn’t have Roth IRAs when you were a teenager, but you could have found something similar. Why the S&P 500? You can’t beat the market systematically, and this provides you with instant diversification. There are probably people out there who can, but you’re not among them. Over time, you will want to move your money into lower-risk assets like bonds that will produce lower-but-predictable returns from year to year. Why a Roth IRA? You pay taxes on it now, when your tax rate is very low, and it grows tax-free for the rest of your life.
4. Set it and Forget It. According to the efficient markets hypothesis, a stock price reflects all publicly available information. You almost certainly aren’t going to be able to earn returns better than you could get from investing in a well-diversified stock market index fund. Your funds will go through ups and downs, and it will contain some real duds as well some real winners. You’re in this for the long haul. While past performance is no guarantee of future results, you can expect to earn what the market returns.
Here’s how to do it. Find a reputable company. I work with Fidelity and Vanguard; there are others that are very good. Sign up through their website. If you don’t have the minimum required investment, sock money away until you do and then try again. If it’s possible, try to set it up so that there’s a monthly draft out of your bank account and into your retirement account. Put the power of inertia to work for you: once you start doing something habitually–like making monthly contributions to a retirement fund or paying for a monthly Netflix subscription–it’s hard to stop.
This requires a bit of discipline that a lot of teenagers don’t have. It’s definitely more discipline than you have exhibited, teenage self: you should, for example, keep your 1986 Ford Escort instead of selling your mutual fund shares to buy a 1989 Hyundai Excel. If you feel like you have to keep up with the Joneses, find new Joneses. This might be tough, but if you can learn how to moderate your tastes now you and your family will be better for it.
This article is based on remarks I gave at a Foundation for Economic Education “Economics of Entrepreneurship” seminar.
I have a free personal finance course on Udemy that might also be useful.