The 12th edition of Deloitte’s Gen Z and Millennial Survey says half of this demographic lives paycheck to paycheck, with the cost of living as their top societal concern.
We live in a fast-evolving world where everyone yearns for financial security. Whether it’s saving up for college, pursuing an entrepreneurial dream, or building retirement wealth, investing has become more challenging than ever. Still, it must be done—and soon.
After all, the rewards of early investing go beyond the basics of time-leveraged wealth accumulation. It is a strategy in itself, setting the stage for more opportunities and giving young investors an edge in navigating the intricacies of personal finance.
According to the Rule of 72, a time-honored method for estimating investment growth, an investment can double in value after a specific number of years, determined by dividing 72 by the annual growth rate. For example, an investment of $1000 growing annually at 4% could have a value of $2000 after 18 years. This tells us that the impact of early investing can take some time, but its long-term returns are well worth the wait.
Here are five ways people can amplify their investment gains just by making an early start:
1. Developing Financial Discipline
Learning financial discipline is the first, all-encompassing benefit of investing early in life. It helps young people master skills and habits that form a strong foundation for long-term financial stability.
When they start investing, they learn the value of saving money. More investments usually mean more returns, so this can encourage young investors to allocate more of their earnings to expand their portfolios. Not only do they develop the habit of setting money aside, but they also learn to budget their resources more effectively at the same time.
By investing early, young people also learn the discipline of maintaining a long-term financial perspective. They will see the importance of looking beyond their present needs and investing in their future. This practice promotes delayed gratification and helps them focus on their financial goals.
In an article published in Fortune Magazine, a wealth management expert recommends investing 15 to 25 percent of one’s post-tax income. In any case, investing shouldn’t be more about the amount of money invested than the total length of time the investment is allowed to compound or increase in value.
Additionally, starting young allows one to develop emotional intelligence early on as an investor. The ups and downs of a market are usually accompanied by the joys and anxieties of the investors behind it. This relationship is widely studied and has even birthed a relatively new field of research known as neurofinance. Also called emotional finance, this knowledge base delves into the extent to which emotions impact individual investment decisions and risk perception.
Neurofinance is still in the early stages of acceptance as an interdisciplinary subdiscipline of economics and neuroscience. However, as humans, we all know how our feelings can prevent us from thinking rationally. Experienced investors know that intense emotions like fear or greed can have catastrophic effects on investments.
The earlier people start investing, the sooner they master the discipline of disregarding emotions and relying on data and analytics when making investment decisions. This alone can cut their losses substantially and safeguard their investments.
2. The Power of Compounding
Compounding is the process of earning from both the initial investment and its gains over time. When a person begins investing early, time becomes their ally. The earlier they start, the more compounding works for them, leading to the exponential growth of their investments.
Imagine an individual investing for the first time at the age of 20 and another at 30. If both investments had an average annual return of 10%, the person who invested earlier would have earned significantly more after five years.
As time goes by, this compounding benefit becomes even more pronounced as returns from the principal investment generate their own earnings. This begins a snowball effect that leads to the dramatic growth of the investment portfolio over time.
Moreover, compounding not only builds on the initial investment but also magnifies the impact of the investor’s standard contributions. By consistently adding more to their original investments, young people can further accelerate their portfolios’ growth.
3. Risk, Reward, and Volatility Education
The earlier a person starts investing, the sooner they understand the critical concepts of risk and reward. They learn that investing comes with inherent risks and that the value of investments can be volatile.
When they become investors, they will begin to appreciate the actual value of their assets as they discover there’s no such thing as an assured return. They will also understand the reasons behind this while witnessing the different factors that impact their investments.
According to Forbes, stocks have been remarkably volatile recently due to geopolitical factors such as the United States government’s COVID-19 response and Russia’s war on Ukraine. This scenario is perfect for young investors to learn from in terms of balancing risks and rewards.
They should see that investments with high potential returns, such as stocks, are usually riskier than more conservative ones, like bonds, which are less profitable yet more stable. This understanding helps them make wiser decisions when investing.
Lastly, early investing gives young people more time to reflect on their failures, assess their performance, determine their strengths and weaknesses, and make appropriate changes where necessary. With more knowledge, experience, and time on their hands, they can refine their strategies and improve their results.
4. A Longer Investment Horizon
Photo by Adam Nowakowski on Unsplash
The term investment horizon refers to the total amount of time an investor intends to hold their investments. A person who starts investing young will have a longer investment horizon, which has many advantages.
For one, it gives them more leeway to overcome challenging but short-term market conditions. Volatility is a hallmark trait of financial markets, but time usually diffuses its impact on investments and eventually allows more favorable trends to surface. In other words, a person who starts investing early will have more time to weather these market highs and lows and avoid significant losses.
Furthermore, a longer investment horizon gives an investor more freedom to take greater risks. Consider growth-oriented assets like stocks. As mentioned, these investments historically offer higher returns, for example, compared to bonds or savings accounts. Yet they are riskier. Nonetheless, with a longer investment horizon, investors have more time to bounce back from any losses and possibly generate more returns over the long term.
A longer investment horizon also enables young investors to maximize the benefits of compounding, as mentioned previously. Starting early gives investments more time to accumulate gains and leverage the compounding effect, leading to significantly more wealth over time.
Aside from having more learning opportunities and time to ride out market fluctuations, a longer investment horizon also offers benefits related to setback recovery. For example, the compounding effect works even when investments are doing poorly. This feature offsets any past losses and helps the investor regain their footing sooner.
In addition, when young investors keep making regular contributions to their investments, their portfolios will grow consistently. During temporary setbacks, their sustained contributions will create a safety net, enabling their investments to recover and grow faster once market conditions improve.
5. Leveraging Tax-Advantaged Accounts
Investing early in life allows people to capitalize on tax-advantaged accounts, improving their long-term investment returns and helping them build more wealth over time.
One example of a tax-advantaged investment account is a traditional individual retirement account (IRA), which comes with perks such as tax-deferred growth and tax-free withdrawal upon retirement. Because contributions to this account may be tax-deductible, investors may also reduce their taxable income, boosting their earnings.
Another type of tax-advantaged investment account is the Roth IRA, which is also designed for tax-free growth and withdrawal during retirement. As contributions to this account are computed after taxes, investors can withdraw their initial investments plus earnings with zero taxes upon retirement.
Employees can also save toward a 401(k) plan, which allows them to make pre-tax income contributions for their retirement. In such an account, contributions will be deducted from the employees’ paychecks either before or after taxes, depending on the options that come with the plan.
Yet another type of tax-advantaged account is a health savings account (HSA), where people make pre-tax income contributions to save for future health needs. These accounts go a long way in healthcare planning by offering tax deductions on contributions and allowing tax-free growth and withdrawals for eligible medical expenses.
When it comes to saving for educational expenses, a 529 plan is a good one to have, offering tax-free growth and withdrawals for eligible education costs. There were 15.81 million 529 accounts in the U.S. as of December 2022. While designed for retirement, traditional IRAs may also serve as college savings.
Again, an early start is an overarching requirement for maximizing the benefits of these tax-advantaged investments. The sooner people contribute consistently, the more they can decrease their tax liabilities, increase their investment growth, and build considerable wealth over time.
Ultimately, starting early with investing is a proactive step for anyone who wants to gain control of their financial future. It widens the playing field for those constantly seeking opportunities to achieve their goals.
However, time is not the only necessity for building long-term wealth. It also requires patience, the commitment to endure temporary market downturns, and the ability to adapt to market shifts without losing balance.
Openness to investment-supportive technologies, such as financial planning software and market news aggregation apps, can also be an asset in itself. So is the humility to work with experts, especially among young and inexperienced investors.
