Building a stock/investment portfolio from a young age is very important for multiple reasons. A stock/investment portfolio built at a young age can help with:
Planting the seeds for possible future financial gains;
Learning how to be financially savvy by experiencing different financial market environments first hand;
Gaining knowledge in different fields and industries and perhaps developing particular expertise over time (ex. Real Estate stocks);
Improving self-discipline and focus.
We will now analyze how starting to invest at a very young age can help in these different areas.
Planting the seeds for possible future financial gains
Compound interest works in favor of the young investor. Money grows over time alling it to compound and increase on an ever-expanding base. The more time your money is kept in financial markets, the higher the expected return. Importantly, the amount you invest in stocks is not a fundamental factor (of course the more you can invest, the higher the potential gains).
The caveat: even though stock markets have averaged between 7% and 16% growth in both developed and emerging markets, returns are rarely stable. This means that a market with an average return of 9% might see multiple years of negative returns in a row and possibly a few years of large gains. Emerging Markets are particularly volatile, thus the importance of monitoring volatility and its higher moments (defined by the more advanced concepts of skewness and kurtosis).
Learning how to be financially savvy by experiencing different financial market environments first hand
This really connects to the first point as it is very important for young investors to maintain composure and not panic during periods of heightened volatility (for example through panic selling in a down market or a financial crisis). Learning what to expect after earning releases and monitoring dividend schedules are a good way to start learning about the mechanics of financial markets.
The caveat: by trying to time the market, that is trying to buy low and sell high, and over-trading (sometimes called overconfidence bias), investors can lose a lot of money in transaction costs and bad investments.
It is therefore important to stay invested and not sell or buy the following personal instincts or after reading a single news article. Therefore the focus should be on seeking conflict points of view on a stock when it is time to buy. Our article on Philip Fischer "Common Stocks and Uncommon Profits", explains more on this topic.
Gaining knowledge in different fields and industry and perhaps developing particular expertise over time
Over time, different investors will be attracted to different types of businesses. For instance, somebody with a degree in medicine could be more inclined to researching healthcare stocks. In addition, investors can also learn about completely new fields thus enriching their personal knowledge and become more cultured.
The caveat: developing expertise in a specific industry or sub-group of companies can prevent a portfolio to be well-diversified. Diversification may seem easy to achieve, but it is in fact one of the most difficult things to master in portfolio management.
This is because the correlation between assets can change over time, making portfolio analysis an important part of the investor toolbox.
Improving self-discipline and focus
The temptation to chase the latest hot stock will always be there, especially after big market gains. Investors should not avoid growth stocks completely in their portfolios but should strive to maintain an asset mix that does not expose them to excessive idiosyncratic risks (which are just risks related to a single specific stock vs systemic risks which are common to all stocks).
The caveat: self-discipline is easier said than done (think about New Year’s resolutions). It is useful to write down the rules you intend to follow for the portfolio and stick to the plan. For example, a rule could be to not invest more than 8% of the portfolio in a single stock (a good rule of thumb).
Comments