2957: You Can Take More Risks When You Invest Young Explained by Kalen Bruce of Freedom Sprout

[00:00:00] This is Optimal Finance Daily. You can take more risks when you invest young, explained by Kalen Bruce of freedomsprout.com.

[00:00:09] One reason it's important for your kids to start investing at a young age is risk. You may have heard that with investing, you're able to take more risks when you're younger than when you're older. But what does that really mean?

[00:00:21] Sure, at face value it means investing in higher risk, more aggressive things like choosing an all stock mutual fund over a stock bond mix. But there's more to it than that. A larger part. Let's talk about that part.

[00:00:35] You can take more risks when you invest young is blanket advice. So first, a word on blanket advice. With my coaching clients, I typically tell them to use the stock market to grow money they won't need for at least five years.

[00:00:50] And to use something more conservative, such as a savings account or municipal bonds for money they'll need earlier.

[00:00:56] But then a question like this comes up. If I need that money in six years, do I just invest aggressively for the first year and then transition into a savings account?

[00:01:07] If that's the case, what happens if my investment dwindles in the first year? Do I still take the money out?

[00:01:13] Well, that's the idea. Like with most financial issues, it's not that simple.

[00:01:18] This is where age comes into the equation. I'm not a big fan of the formulas for everyone because we're all in different situations. That's why personal finance is personal.

[00:01:29] Here's a popular example. Subtract your age from 100 and hold that percentage of your portfolio in stocks while holding the rest in bonds.

[00:01:38] In this example, a 30-year-old would own 70% stocks and 30% bonds. That formula may work for some people, but I know more than a few 30-year-olds who would rather have more than 70% in stocks.

[00:01:51] I was one of them. These formulas rarely apply to everyone's situation.

[00:01:56] So how does this apply to what we're talking about?

[00:02:00] Flexibility.

[00:02:01] The number one benefit of investing young.

[00:02:05] Younger people can take more risks, such as having a higher percentage of their investments in stocks as opposed to bonds, but that's not really the main thing.

[00:02:13] The main thing is choice and flexibility.

[00:02:16] The only way I know to explain this is through an example.

[00:02:19] Two examples, actually.

[00:02:21] Example number one, playing it safe.

[00:02:24] Let's say this same 30-year-old we've been picking on wants to save for a house.

[00:02:28] He wants to pull the money out for his family's home in four years, so he and his wife play it safe and use a savings account.

[00:02:36] They've been working hard to earn extra income and are able to save $1,000 a month.

[00:02:40] At the end of four years, they will have saved $48,000, and with their savings account interest, they will have earned around $360, assuming a 0.5% interest rate, which is a fairly standard rate.

[00:02:53] In total, they have $48,360, not much more than the amount they saved.

[00:03:01] So now, at age 34, they can buy a small fixer-upper in some states or apply a decent down payment in other states.

[00:03:08] Example number two, taking a risk.

[00:03:12] Let's say this 30-year-old decides he doesn't like the sound of example one, so he opts for a riskier path.

[00:03:18] He still plans to pull the money out in four years, but instead of a savings account, he uses an S&P 500 index fund,

[00:03:25] a fund that distributes your money across the largest 500 companies in the U.S.

[00:03:30] Riskier, but more potential for reward.

[00:03:33] Assuming he earns the fairly conservative average of 8% per year at the end of the four years,

[00:03:38] his family will have $54,073 to spend on their home,

[00:03:43] contributing the same $1,000 per month or $48,000 total.

[00:03:47] If the market performs above average, around 16% for the four years, which isn't totally unheard of,

[00:03:54] they'll have over $60,000.

[00:03:57] All of that would be ideal.

[00:03:58] But what if the market crashes a year after they start investing for their home?

[00:04:03] This is where it pays to be young.

[00:04:06] At 34 years old, they have plenty of time to come back from a loss and still get to that $50,000 to $60,000 range,

[00:04:14] assuming they don't freak out and pull all their money out.

[00:04:18] Therein lies the main benefit of being young.

[00:04:20] They can stay flexible.

[00:04:22] If they would have been in their early 60s when they started,

[00:04:25] they may not have the time to wait 1, 2, or 10 years to accumulate the money they need for their home.

[00:04:32] Young means flexible.

[00:04:34] When you're young, you're flexible in what you can afford to invest and what you can afford to lose.

[00:04:40] Since you don't really lose money in the stock market until you pull the money out,

[00:04:44] younger people have time to wait it out.

[00:04:47] They have time to change their plans and make new ones.

[00:04:50] When you're young, it pays to avoid sticking with an exact path

[00:04:54] and be willing to make adjustments when things don't work out.

[00:04:57] The ability to stay flexible is a greater benefit than merely investing in more aggressive funds.

[00:05:04] The ability to stay flexible is the key to earning more on investments.

[00:05:08] It pays to have a plan A, B, C, and so on.

[00:05:12] The most important thing with investing is starting young

[00:05:15] because time is what leads to successful investing.

[00:05:22] You just listened to the post titled,

[00:05:24] You Can Take More Risks When You Invest Young,

[00:05:26] Explained by Kaylin Bruce of freedomsprout.com.

[00:05:29] And I'll be right back with my commentary.

[00:05:32] I liked the example Kaylin used in this article.

[00:05:35] It's great food for thought because many people wonder

[00:05:38] where they should keep the money they're saving for a home

[00:05:40] and they feel that a savings account is too conservative.

[00:05:44] Warren Buffett wrote in his 1996 shareholders letter,

[00:05:47] quote,

[00:05:48] If you aren't willing to own a stock for 10 years,

[00:05:51] don't even think about owning it for 10 minutes, end quote.

[00:05:54] And while this is advice that I live by,

[00:05:57] it doesn't take into account how flexible someone is willing to be.

[00:06:01] If you'd like to buy a house in five years,

[00:06:03] but it wouldn't be terrible if you had to wait 10 years,

[00:06:06] perhaps investing isn't a bad idea at all.

[00:06:10] All investing involves risk,

[00:06:11] but the time horizon is a critical aspect of said risk.

[00:06:15] So investing in the short term is riskier than holding cash

[00:06:19] because you take the risk that there could be a market correction

[00:06:22] right before you plan to use that money.

[00:06:25] But over the long term,

[00:06:27] holding cash is much riskier

[00:06:29] because its value diminishes due to inflation.

[00:06:32] So you're almost guaranteed to lose money over time.

[00:06:36] Flexibility on your short term financial goals

[00:06:38] may be the secret ingredient to managing short term risk.

[00:06:42] If you're willing to say,

[00:06:44] I'm going to invest $50,000 for my home payment,

[00:06:47] and I commit to not touching it until it reaches $60,000,

[00:06:51] regardless of how much time it takes,

[00:06:53] I think that's a level of flexibility

[00:06:56] that warrants investing for the short term.

[00:06:58] And that should do it for another edition of Optimal Finance Daily.

[00:07:02] I'll be back tomorrow as usual.

[00:07:04] So I'll see you there on the Wednesday show

[00:07:06] where optimal life awaits.

[00:07:07] Optimal Finance Daily