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Important Investment Lessons for Young People

If you are an investor under the age of 40, you have one big advantage over everyone else: you have an incredibly long investment time horizon during which to grow your investment dollars. Here is how to take advantage of it.

If you are an investor under the age of 40, you have one big advantage over everyone else: you have an incredibly long investment time horizon during which to grow your investment dollars.

The power of compounding is one of the great wonders of investing. The benefit of an extra decade or two can make a huge difference to your ending wealth. To capture this benefit, you have to start investing early and intelligently, and with consistency and discipline. After all, it is only with regular, long-term success that financial goals are realized.

For most investors, staying focused over the long run is challenging. The temptation to speculate can be high, and there is plenty of noise and distraction vying for your attention, making 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. Some of it is the financial press trying to get catch your attention to sell advertising. 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 keep disciplined and stay the course.

The bottom line: it is not the day-to-day fluctuations of markets that should concern you. The primary risk you face as a young 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 the difference between comfortable portfolio and a safe one. A comfortable portfolio does not fluctuate much in value. It might be invested in stable things like bank CDs with an expected return not much more than the rate of inflation. Alternatively, a safe portfolio has expected returns well above inflation. It is invested predominately in stocks and highly diversified. This equity oriented portfolio fluctuates with market movements and can be uncomfortable especially during stock market declines but it provides for long-run inflation protection.

As a young investor, you may not have made a lot of investment mistakes. That can be good and bad good because you havent lost money; bad because you havent learned any lessons the hard way. As one of my colleagues likes to say: the market is a great teacher, but it charges a steep tuition. You can skip the tuition payment by learning how to invest prudently early on.

Remember that 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. Capitalism generates positive returns overall, and, although some win more than others, everyone can succeed. 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.

One of your main goals should be to capture as much of the global return on capital as you can. Cut your investment costs, make sure you have a widely diversified portfolio, and stay disciplined. Investing this way, you can have a successful investment experience!