Investing basics for first timers

The students of 2020 are graduating to the adult world in one of the most uncertain times in recent history amid recession, pandemic and global political tensions.

The prospect of working, saving and investing is a daunting prospect – and the hope of home ownership must seem an eternity away.

In times like these, knowing the basics of how to get started down the road to prosperity is more important than ever.

Here are five tips for the class of 2020 to keep in mind as they navigate their financial futures.

Budgeting

Charles Dickens wrote a famous argument in favour of financial prudence when he said the difference between happiness and misery was spending a mere sixpence less – or a sixpence more – than you earn.

Budgeting effectively is the first and most critical financial lesson. Knowing how much is coming in and going out is critical to building good money habits.

Next, the trick is to regularly put something away into savings.

Some call it an emergency fund, others say they are saving for a rainy day. The result is the same – a lost job or an unexpected bill can be financially devastating and having funds to protect from the unknown is critical.

Only once that emergency buffer is stashed away in a bank account should new investors consider moving future savings into higher return investments like the share market.

Understanding debt

The rise of buy now pay later services would have you believe that younger generations have turned their back on bank loans forever, but traditional forms of lending will still play an important role in their financial lives.

The trick is to distinguish between debts that help build a better future and those that simply fuel lifestyle.

Student debt for university is generally one of the good debts, setting up a higher income earning future through better education. A mortgage puts a roof overhead and builds equity in an important asset. Carefully borrowing to invest is also a strategy many use successfully.

But credit card debt can be a threat to personal financial stability, as are personal debts like car loans.

It is important young adults tread carefully when borrowing and carefully consider what kind of debt they are taking on.

Super

Retirement must feel very distant, but superannuation remains the single most attractive way for most people to save and invest.

The tax advantages of super are well documented – contributions and earnings are taxed at just 15 per cent. Low-income earners like many school leavers can even qualify for top-up contributions and tax offsets from the government.

It is important to stay on top of super, know where contributions are going, ensure the asset allocation is appropriate and watch out for high fees.

Expect volatility

As young adults start to build an investment portfolio, saving for a car, home or retirement, one of the first lessons they learn is that from time to time, investments have a tough year. Ups and downs are to be expected.

And while accessing the share market is easier than ever with the rise of cheap brokerage accounts, sensible investing is not about collecting shares in brand name companies in a phone app.

Instead, the key to success is found in diversification and deliberate top-down portfolio construction. Top-down portfolio construction means establishing your asset allocation settings to match your personal risk profile.

Being diversified means the chance of any one failed investment hurting your overall returns is minimised.

Managed funds and ETFs allow investors to own thousands of different investments in different countries, different industries and across multiple asset classes.

Understand compounding

Finally, young investors should spend some time wrapping their minds around the power of compounding.

The concept of something growing faster the bigger it gets is strange to comprehend but that’s exactly what investments do.

Over the past hundred years, it was not uncommon for a portfolio to double in value about every 10 years. That means that after the tenth year, the accumulated returns are bigger than the amount originally invested and from year 10 onwards, the investment returns alone produce more gains than the original investment itself.

Understanding this helps young investors realise that their small investments today will drive outsized returns if given enough time.

After all, time is the biggest asset that the young possess.

By Robin Bowerman
Head of Corporate Affairs, Vanguard Australia
24 Nov, 2020
vanguard.com.au