Young investors have two primary benefits relative to their elders: time and room for error.
The young investor has an extended period to reap the advantages of compounding. Plus, higher risk tolerance can help them reap higher returns. Finally, young investors have smaller portfolios, and mistakes are often less costly.
Starting investing early will grow more wealth. And it will also develop the behavioural competence necessary to preserve that wealth down the road. Behavioural investing biases become more destructive as a portfolio grows in size.
In this post, I focus on the five key benefits of investing while young.
Many complexities and obstacles in life make investing at a young age difficult. It’s better late than never.
Table of Contents
1. More Time For Compound Growth
This plot shows the importance of time.
Comparte two investors who each invest $1,000/month at an 8% return.
George starts investing at age 20. Fred parties it up and decide to start at age 35. Both Fred and Georgie make the same income.
See the difference?
|Starting Age||Final Value @ Age 60||Amount Contributed||Total Investment Investment Value|
Time Invested > Amount Invested
My plot shows returns as smooth. In reality, stock returns are choppy from year to year. In some years you’ll see +30%, others -20%. To better understand reality, you can check out this post on 30 Years of Stock Market Returns: Top Pains and Gains.
2. More Risk Tolerance: Higher Future Returns
A longer time horizoncan help increase your risk tolerance. And an increased risk tolerance means a young investor can take on more investment risk. This can result in higher expected returns.
Two key factors increase a young investor’s ability to take on risk:
A long time horizon gives you the time to recover from market crashes. A 25-year-old investor will have 30+ years available before relying on the investments. A 20% crash during one of the years of investing is not a factor.
Future earnings power means young investors can lean on earnings power instead of investments. Any losses, even if permanent, can be recovered by improving skills (or working longer) and earning extra income. This earnings power is called your human capital.
High Risk Tolerance: Investment Returns
With a higher risk tolerance, you can invest in riskier assets such as stocks instead of bonds.
With more risk comes higher expected long-term returns.
I reflect on the last 122 years of stock and bond returns to show the risk-return relationship. Assets like stocks have returned 5.3% after inflation, while less risky assets like bonds have returned 2.0% after inflation.
3. High Tolerance for Error: Lower Tuition Costs
Young investors often have small portfolios relative to their future earnings power. A 50% loss in a $1,000 portfolio is only $500. That’s only a few weeks of work.
A 40-year-old with a $500k portfolio is slightly different, as there is less room for error. A 50% loss may equate to 10 years of savings down the line. No fun.
Eight years ago, I made some investing mistakes. I fell into yield traps, I was overconfident in my ability to understand individual businesses (stocks), and I lost money in options in the TFSA. Overall, I underperformed the market by about 2%/year.
But my investing mistakes were necessary. I believe there is no better motivator than the pain of losing (see loss aversion).
Here are some common investing mistakes:
- Buying speculative stocks or crypto that rapidly dive to zero (Behavioral).
- Over-estimating risk tolerance and panic selling during market downturns (Behavioral).
- Buying an individual company that gets clobbered by competition and the stock falls 90% (Technical).
- Buying options contracts with limited understanding and losing 100% of your money (Technical).
Although losses hurt young investors, the total loss will be minor relative to lifetime income. These losses are tuition that improve competence for the future when your portfolio is larger.
4. Technical Abilities Grow with Portfolio Size
You don’t want to start investing with zero investing knowledge. But you also don’t have infinite time to spend learning about investing.
Eventually, you must DO.
Perfection leads to a state of analysis paralysis. Then I don’t remember you investing.
I started investing by learning about the technical basics of stocks and opened a practice investing account when I was 18.
Eventually, I had to get skin in the game with real money.
I was 23 when I opened an individual trading account in a TFSA and bought my first stock.
I had to learn about brokerage, and how to place a trade. In addition, having real money in the game motivated my learning.
Once the TFSA was maxed, I had to learn about taxes on investment income.
During this time, I made technical errors. I did not understand exchange fees when buying US stock, I paid commissions on multiple small trades, I was under-diversified.
After years of learning and minor mistakes, I now invest in 100% index funds.
Young investors have sponge-like brains, time to learn, and more room for error. They can learn about investing incrementally, making learning fun and less overwhelming.
5. Time To Develop Strong Investor Behavior
Later in life, when a portfolio is extensive, behavioural biases can cause huge losses.
Behavioural control is superior to technical knowledge when it comes to investing success.
Common emotion-driven errors include panic selling, impatience, or buying speculative assets due to fear of missing out (FOMO).
Such behaviours erode returns by incentivizing you to “buy high” and “sell low”.
I think it’s super interesting that panic selling and FOMO are rooted in Loss Aversion.
DIY investing from a young age trains mental and emotional resilience. When the 50% stock market crash hits, this resilience will be necessary to limit behavioural investing errors.
Young investors can increase emotional fortitude as their portfolio grows.
Getting investing behaviour under control at a young age prevents mistakes when a portfolio is large.
Benefits of investing while young include higher returns, more time for compounding, and superior long-term investing competence.
From what I’ve seen, human behaviour is the main limitation for younger investors. Over-confidence, impatience, speculation, and panic selling are the main limitations.
It’s hard to detect these biases as confidence peaks for young humans, especially young men. This was certainly the case for me. It took a while before I was humbled.
Before jumping in to invest, I recommend you read 9 Signs, you Are Ready to Invest. In addition, there is a balance between learning and doing. Eventually, to get better, you must take action.
By putting some money at risk and making some errors, you learn by doing. This type of learning sticks and will reap the rewards in the future when the stakes are higher.