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Six lessons for a beginning investor

Reprinted courtesy of MarketWatch.com.

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While relaxing with my college-age daughter, Lexi, at Cannon Beach over a recent weekend, we got to talking about how people her age can become successful investors. I asked her to help me build a list of habits that would lead young investors in the right direction. She gladly accepted this assignment, and we had a marvelous conversation.

So here are six “lessons from Lexi,” each one worth teaching to a young person. And since they come from a young person, maybe that will make them more palatable. They are not listed in any particular order.

1. Be willing to start small. The biggest step is to get started investing, even with a very small amount. Many people instead wait for years until they have paid off their student loans or they’ve done all the things young people are supposed to do before they “grow up.” In doing that, they are squandering the precious resource of time — time for even a modest investment to grow.

Parents and grandparents can sometimes help financially. But ultimately it is the responsibility of each young person to hop on board the investment train. Sooner is much better than later.

2. Saving money is essential to becoming a successful investor. For young people, that means knowing the difference between a “want” and a “need.” The very act of saving money is an act of deferring gratification. This can become a habitual mindset, and it doesn’t have to be onerous.

Lexi understands that she doesn’t have to eat in restaurants as much as some of her friends do. She told me her grocery budget is $25 to $40 a week, and she rewards herself in a restaurant every two or three weeks. (And she prefers inexpensive Thai food instead of some expensive splurge that might impress her friends.)

We found an interesting article about how much money young people are spending eating out. Here’s a quote from it: “They are the generation saddled with more student debt than ever before, yet 16- to 24-year-olds are spending more on food than any other age group because they know so little about cooking, research reveals.”

3. Acquire some knowledge. Lexi knows that at least once a year, I will give her a multiple-choice quiz to make sure she is absorbing the things I’m trying to teach her. So she pays attention. The test is normally given while we’re driving, and she knows that if she gives the wrong answers, she will likely have to endure a long lecture or explanation from me.

Fortunately for me, for her, and for you, the test isn’t hard, and the lessons are easy to learn. Here are three examples:

  • To build retirement savings over a lifetime, which is likely to make more money, stocks or bonds?
  • If you’re investing in stocks, should you own just one or two, or should you own many?
  • If you’re buying a mutual fund, should you choose an expensive fund or an inexpensive one?

These are obviously simple concepts, second nature to most serious investors with some experience under their belts. But you might be startled at how few people understand investing enough to get these right.

Lexi and I have also discussed what I believe is the one time it might make sense to invest in an individual company. That would be when you start your own company by “investing in yourself.” It’s obviously risky, but you might get a big return along with the ability to be your own boss.

4. Put your investing on automatic pilot. If you wait until you feel like setting money aside, you might wait a long time. Lexi knows this, and that’s part of the reason for her first two points above.

Most investors get in trouble by making buy and sell decisions based on how they feel at the moment. Instead, they can easily set up automatic investment plans and then just not worry about trying to take advantage of (and avoid getting hurt by) the ups and downs of the market. This is called dollar-cost-averaging, and it has worked well for many decades.

5. Be patient. And when you are tired of being patient, be patient some more. This advice may seem strange coming from a college student, but Lexi has done a good job of learning from some of the numbers I have tried to teach her.

At its extreme, impatience looks like this: Investor buys a stock or mutual fund. Investor waits until the next day and checks the price. If the price is higher, investor “knows” he has chosen a winner. If the price is lower, he “knows” he picked a loser.

As Lexi might say in her blunt language: Are you kidding me?

There’s an expected long-term premium return for investing in a broadly diversified portfolio of stocks. But the long term might be a long time coming. A lot of it depends on the luck of when you start.

Investors who were fortunate enough to start in 1975 experienced a quarter of a century of returns of 17%-22% in major groups of stocks. But, through no fault of their own, an earlier generation didn’t fare so well. From 1960 through 1974, returns on those same groups of stocks were in the range of 4%-7%.

But as I’ve told Lexi many times, longer periods are much more reliable. Since 1928, the average 40-year return on diversified stock portfolios has been from 10% to 16%.

And that’s just 40 years. A 25-year-old today has a good shot at 70 years of investing returns ahead. If they can be patient, they will most likely be rewarded.

6. This one is easy. Practice picking up the phone, put it to your ear for a moment, then hanging it up. Yup, it’s that simple. This is what you should do when you get a phone call from somebody offering a get-rich-quick opportunity, whether it’s a commission-based salesperson or an advisor wanting to let you in on an “amazing” opportunity.

I suggested that Lexi do this exercise 10 times a day for a full month, and I suggest you do the same. (You can do it in your spare time in the privacy of your own home!) You’ll get so used to it that you will never have to wonder what to do when that sales pitch arrives.

Lexi and I have discussed these lessons for years, and they are all good. I hope you share them with somebody who could benefit.

It comes down to habits and attitudes. If you’d like my take on the subject, you’ll find it in a video of a keynote address I gave to investors earlier this year.

Richard Buck contributed to this article.