One of our DollarsAndSense team members was recently invited to moderate a panel discussion at the FSM Invest Expo 2018. Held on 6 January 2018, this free investment event was hosted by Fundsupermart and ShareInvestor, and covered key investment themes relevant for 2018.
During one of the exchange, an interesting argument was presented for why young people can actually have more to lose than many older folks and cannot take as much risk when it comes to investing.
This is exactly opposite to common advice young people receive.
“Don’t Worry About Losing Money In The Short-Term, You Can Ride Out The Volatility In The Long-Run.”
We’re not trying to say this is bad advice. In fact, it really makes sense when you reason that young investors have their whole lives ahead of them to ride out volatility in the markets. And this is why they should be able to take on as much risk as they can and get invested as soon as possible.
Add to the fact that young people have warmer blood and tend to engage in riskier behaviour regardless, and it looks inevitable that they’ll end up taking riskier investments.
Any losses you incur in the short-term, you can treat in one of two ways. Firstly, losses from market movements can be covered over the long-term as you ride out fluctuations in the market and the economy, and you also continue receiving dividends in the meantime.
The other way losses are brushed off is usually with the notion of “paying tuition”. This is the cost young people pay, in investment losses, to learn the ropes of investing. Again, this doesn’t sound too outlandish as young people usually have less to invest, and hence less at stake, and their losses would also tend to be less. Any experience they gain, can be used to greater effect when they have more money (when they’re older).
Also, because they have a long way to go in the markets, young investors are also advised to take bigger risks. The argument is that with bigger risks, come bigger returns, and all you have to do is play the long-term game to see the returns.
Why You Actually Cannot Afford To Lose Money or Take Big Risks
The problem with taking big risks is that you can also incur big losses. And, because you have only a little to start with, this is untenable and its effects can be magnified. Let us explain.
#1 Capital – You Don’t Have Much To Start With When You’re Young
While losing some money at the beginning of your journey to become an astute investor might be acceptable to some, the problem is that you don’t have much to start with in the first place when you’re young.
This means that after a few episodes where you lose money, either through volatile markets or “paying tuition”, you’ll run out of money and confidence. This can be damaging not only to your retirement plans in the long run, but also your determination to continue investing.
#2 Risk-Seeking Behaviour – With Bigger Risks, Come A Very Real Possibility Of Lower Returns
Just because you’re a young investor does not mean you need to listen to the “experts” and take more investment risks. This is because taking bigger risks does not necessarily translate to a bigger return. The truth is that you’re more likely to end up with sub-par returns.
You could easily take a high-risk position and end up earning returns that even a low-risk position would have beaten in the course of the year. This is because some high-risk returns might turn out to be really bad investments (hence the higher risk associated with it).
Multiply this by a decade of youthful exuberance and the difference in your investment portfolio could be stark.
#3 Lack Of Experience – Young Investors Usually Have Time, Not Acumen
Sometimes, it’s not that taking big risks is a mistake. The problem lies with the person that is taking the big risks.
When an experienced investor takes a big risk, he or she knows exactly what they’re hoping for and would also know when to get out of it. This may not be the case for young investors who are just starting out, and blindly subscribing to the mantra of taking big risks.
#4 Time Is Your Friend, Not Your Foe – Your Losses Are Magnified By The Effects Of Compound Interest
You’ve surely heard of the term compound interest – it’s when you start earning interest on the interest that you’ve already earned in the past. When this happens over the long-term, your wealth can grow to a sizeable amount you can comfortably retire on.
The problem with losing money early on is that the same effect will be at play. The younger you are, the more time your money has to compound. Any money you lose today could have compounded into a significant amount when you retire, in 30 to 40 years, if you had just been more careful.
Even if you’re able to recover your losses and earn decent profits on your investments after a while, you still need to consider how your portfolio could have grown if you didn’t lose money very early on. It would very likely have far outstripped your returns.
#5 Visibility Into The Future – Young People Have To Consider Their Requirements Over An Extremely Long Time, Compared To Older People
In this last point, an argument could also be made for older people being in an advantageous position to take bigger risks. This is because they’ve gone through the raising their children, paying for their homes and have greater sight into how long they will likely have left.
This allows them to make a more accurate prediction on how much they should need in retirement. Now, they could actually afford to take greater risks with any money that is in excess of what they should require in retirement.
Conversely, younger people are unlikely to have gotten married, bought a home, consider how many kids they want or even know what kind of world (and inflation rates) they will be facing in the long-term. This actually puts them at a disadvantage to older people when it comes to being able to making accurate predictions about their long-term needs.
Invest Prudently And Think About The Long Term
At the end of the day, it shouldn’t matter whether you’re young or old. You should be investing prudently, and trying your best to reduce the level of risks you’re taking on and earning as high a return you can.
This comes with experience and knowledge, which you need to build from day one. There’s no shortcuts, you’ll need to read articles like this, ask question to those with more experience and gain first-hand experience investing.
Younger investors also have to deal with the greater uncertainty over what the long-term actually holds, and this is why you should be even more prudent when it comes to investing.
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