If we could teach young people just one thing to improve their chances of financial success, it would be the concept of compounding. Only when your investment gains begin to earn investment gains of their own are you truly on the path to building meaningful wealth.
Yet this message isn’t getting through. In the most recent global study of financial literacy, the U.S. ranked just 14th in the world when it comes to understanding basic concepts such as diversification and compounding. That was reported by S&P Global, the World Bank and Gallup in 2015.
This shouldn’t come as a shock, as two-thirds of parents say they are reluctant to talk to their young people about money, according to recent polls. But there is a simple way to jump start this conversation: Give your children or grandchildren the gift of an investment.
We’re not talking about old-fashioned savings bonds, which young people have been getting from grandparents for generations and that currently pay just 0.10% in annual interest. These days, parents can just as easily gift shares of companies their children can appreciate, such as Apple, Netflix or Nike. Or better still, gift them shares of a mutual fund that offers exposure to the broad market.
Part of the benefit is simple: We need to boost young investors’ overall exposure to equities. A survey conducted by Gallup last year found that only 37% of young adults (those younger than 35) owned stocks in 2017 and 2018, down from 52% before the 2008 market crash. Apparently, the effects of the global financial crisis and recent stock market volatility linger in their psyche.WATCH NOWVIDEO03:51Niall Ferguson reveals the best ways to save when you’re young
Yet if a millennial owned shares of a broadly diversified equity fund back then, they would have witnessed several important things:
- Stocks may sink from time to time, but over the long run they go up. Say a millennial invested $1,000 in the average blue-chip U.S. stock fund on Oct. 9, 2007, when equities slipped into a bear market. Yes, that original investment would have shrunk to $460 by March 9, 2009. But by Dec. 31, 2018, that original $1,000 investment would have grown to $1,750. That’s $700 more than they would have earned had they “played it safe” in three-month Treasury bills.
- Stocks rise more frequently than they fall. Even in the worst decade for the markets since the Great Depression, from the dotcom crash in 2000 through the end of the Great Recession in 2009, the market rose in more years than it fell — 6 out of 10. And since 1926, what is now the has risen in 68 calendar years, which represents a success rate of more than 74%.
- “Timing the market” is bad. Some of the worst years for equities have been followed by some of the best years. For instance, the S&P 500 rose more than 26% in 2009, after falling 37% in 2008. Trouble is, you won’t enjoy those surprising up years if you follow your instincts and head for the exits when things look scary.
- “Time in the market” is good. If an 18-year-old is gifted $1,000 in a blue-chip stock fund today, and then invests just $1,000 more every year for the next 49 years, and keeps reinvesting the gains, he or she would wind up with $1.2 million by age 68. This assumes that blue chip U.S. stocks will continue to deliver 10% annualized returns, as they have since 1926. But if you waited until turning 35, how much would it take in annual investments to get you to $1 million? Roughly $4,500 a year. And if you wait until you turn 45, you’d have to sock away more than $12,500 a year to get to seven-figures.
It just goes to show how valuable an investment gift can be. While savings bonds may seem quaint today, they played an essential role in rebuilding the confidence and finances for families who lost wealth and faith in the aftermath of the Great Depression. In the aftermath of the global financial panic and Great Recession a decade ago, an investment gift in stocks or a fund can teach real lessons in why it pays to invest early and stay invested.
Original source: CNBC News