I recently had a conversation with a former student of mine who is looking to invest in the stock market. He’s in college now and has some money sitting around that he doesn’t need for school. He wanted to know how to invest 1,000 dollars or more at this stage of his life and whether it was realistic or not.
His situation is similar to what many 18-year-olds face. They’ve worked full-time summer jobs since they were 16 and maybe even part-time ones during the school year. Their college expenses are taken care of either through scholarships or the bank of mom and dad. The money they have earned is just sitting in their savings account drawing little to no interest. Does it make sense for them to do something else with it, like beginning to invest?
The answer is “YES…Absolutely!” but with a very big BUT.
Before I get to the BUT though lets look at some assumptions about 18-year-olds that are going to impact how they invest and where they put their money.
Assumptions About 18-Year-Olds
While not true for all, these generalizations pretty much highlight what most 18-year-olds are going through:
- They are looking towards college or vocational school (immediately or at some point). More education or training is the next step for most 18-year-olds. They know completion of some kind of advanced degree will offer them the chance at securing better employment. Until they get it they will be locked into common laborer type jobs, which are not all bad but not probably what they anticipate doing long-term.
- They are emotional. We are all emotional at some level but youth are more so. In fact, their emotions often drive their decisions more than their intellect. This leads to many unwise choices that have varying levels of consequence.
- They lack life experience. It’s not their fault they lack experience. They just haven’t lived enough life yet. Experience is a great teacher and an 18-year-old has less of it to benefit from.
- They want a better financial life and have heard investing is a way to make money. I’ve only met a few seniors in high school who truly understood investing. Most have a casual notion what it means from news items they’ve picked up or from hearing their parents discuss it around the dinner table. They probably don’t know how to invest 1,000 dollars and may even be turned off/discouraged from even trying based on how they’ve heard other people lament their investing misfortunes.
- They have other things on their mind. Although making money might be important they have so many other things that dominate their thought life. College classes, events and parties, experiencing life, relationships…the list goes on and on.
All of these generalizations about what life is like for an 18-year-old will have an impact if they choose to invest. Their investing success could be hindered by decisions made out of emotion, lack of experience, and a desire to focus on college and other things.
In order to invest though, a young person needs to understand the why and deal with one caveat before they transfer their hard earned savings to an investment.
Why Should I Invest at 18?
This is the big question young people ask. They think, “What’s the point of me learning how to invest 1,000 dollars a year right now now? Won’t there be ample time to invest once I graduate from college and start my new career? I’ll be making more money then and have more to invest.”
While all that may be true other factors come into play that – because of their lack of life experience – they cannot see.
Life will be more expensive after college. There may be loans to pay back. You might get married, need healthcare, have a kid, buy a house, move to an expensive city…ugh – the expenses are already getting out of hand.
The money that was supposed to be available to invest because of that cushy new job is going to many other places.
This points to the biggest reason you should invest at a young age – time. Time is the biggest part of the equation when it comes to investing. An 18-year-old has more time to invest than a 25 or 30-year-old. Waiting seven or 12 years to invest can have a dramatic impact as seen in the following math problem:
Lets say “Person A” begins investing at 19, just one year out of high school. She contributes $150 per month ($1,800 per year) for 8 years, until the age of 26. The total amount of money she invested equals $14,400. If that money were to average 12% return per year, by age 65 that investment would have grown to $2,264,026. Keep in mind that is without investing another dollar after the age of 26.
Then we have “Person B” who waits to begin investing until age 27. He contributes $150 per month ($1,800 per year) for 39 years, until the age of 65. The total amount of money he invested equals $70,200. If his investments were to average the same 12% return, he would have only amassed $1,580,051 by age 65. Person B invested $55,800 more actual dollars over the investment period yet fell $683,975 short of the mark achieved by Person A.
What a difference time can make. (To play with your own figures, use the investing calculator here. You’ll find the same scenario no matter what dollar amount or rate of return you plug in. All other things being equal, starting earlier always wins. )
So yes, you should begin investing at an early age. However, – and here comes the BUT – only if you don’t need to money in the next five years. There are two big reasons why this is important:
1) Market Corrections. Stock prices go up and down on a daily basis. Sometimes those daily price fluctuations are sustained, meaning they go in one direction (up or down) for an extended number of days. A negative market correction can easily eat into the principal amount you invested. So you could see your $1,000 investment split in half in less than a year if the market is in a tailspin.
The good news is that the stock market doesn’t always go (or stay) down. It rebounds from its lows but it always takes time. A five-year window gives you time for stock prices to go back up.
2) Taxes. Taxes can eat into the rate of return on your investments. If you have gains on your investment (meaning the market has gone up and your shares are worth more) and you choose to sell, you will pay taxes on how much you gained. If your $1,000 investment goes to $2,500 and you sell, you’ll pay taxes on $1,500 worth of gains.
Everyone has to deal with taxes on investment gains. But if you are constantly in and out of the market you’ll have a greater chance to pay too much in taxes.
How to Invest 1,000 Dollars the Right Way
For my money, the best place for a beginner to get started is with an Index Fund that tracks a large section of the stock market. This could be a fund that tracks the S&P 500 (the 500 biggest companies) or the total stock market. Either way you’ll find your money diversified (spread out) because these funds are required to hold all the companies in the index they are tracking.
(Disclosure: This is the route I took when I started my 403(b) retirement account, my first real investment. 75% of the money I invested went into the Vanguard 500 Index Fund and 25% went into the Vanguard Total International Stock Index Fund. I’ve continued to be invested in those to this day, while since branching out into other funds inside and outside my retirement account.)
Index funds will help you with several things:
- They are low on expenses.
- As stated already they just track the market. Whatever the market does, they do. In that sense they help reduce some emotion that comes with stock market performance.
- They will allow you to focus on what’s important in other areas of life without having to worry about a poor fund manager managing your money improperly (it happens).
- They will give you some basic investing experience and you’ll be more prepared to invest post-college.
Index funds can be found at investing companies like Charles Schwab, Fidelity and Vanguard among others. You can simply search a company’s website to find the kinds of index funds they offer. You’ll notice that most index funds have a minimum amount of money you must invest with some being higher and others lower. So how much you have ready to invest may determine what company and what fund you choose.
You will have to open an account with your company of choice, fill out an application, select your fund(s) and then send in the money. That can usually be done either by a check or wire transfer from your bank account. Once your money is received they will invest it in whatever funds you’ve instructed. The process really is quite easy.
Some Final Thoughts For the Young Investor
If you have money sitting around that you won’t need in the next five years, I’d encourage you to invest it. It’s not a complicated process to get started and it won’t be something you have to monitor on a daily basis. In fact, I’d discourage you from paying attention to your investment fund every day. Checking on it four or five times a year is all you need to do if you have a long-term perspective.
The sooner you can get started with investing the better. All those people who didn’t start until their 30s or 40s are regretting it to this day. Time is on your side but it won’t be if you let it slip away.
Questions: When did you get started with investing? What was your first ever investment? Were you thinking about investing during college? For those who are older, what investing advice would you give to an 18-year-old? What other advice would you give on how to invest 1,000 dollars to an 18 year old?