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A quick investing cheat sheet for under-25s, from one twenty-something to another

Don't worry millennials, we're not here to berate you about loving smashed avocado on toast.

The Register and NZ Retail editor and associate publisher Sarah Dunn is a big ol’ geek who got on a waiting list at the library to read Talking to My Daughter about the Economy for free as soon as it came out. When her younger co-workers asked for advice on getting their money under control, she wrote the below.

Disclaimer: I have no financial qualifications and am not any kind of professional investment advisor. This is opinion writing that’s based on my personal experience only. Seek other advice before making investment decisions!

Why the stock market?

Inflation is eating your money. Frittering money away on food and consumer goods because it’s easy to access is eating your money. Property may well be out of reach right now, but you need to invest in something ASAP to build passive income into your life.

Unless you have a side hustle, or somebody you trust 100 percent needs a carefully-documented financial backer for their business, there’s not a lot of good options for investing small amounts of money.

Note: Other options do exist, obviously. Term deposits and peer-to-peer lending seem to be the best of an uninspiring bunch. Equity crowdfunding and minerals should be viewed with suspicion. Bitcoin is fascinating and I might have a play with it when I’m more on top of my mortgage, but it’s better described as speculating at this stage.

Why passive income? And how much should I invest?

If you start in your early 20s, investing roughly 15 percent of your yearly earnings is a good goal that will ensure you a prosperous, comfortable future, but if you wait, you’ll have to save a lot harder, later, to get the same amount of money stashed away.

Compound interest – getting paid interest on the interest you’ve already earned - means that small amounts saved now will make a huge difference later in life. Go look at Mr Money Moustache or the Deep Dish if you want to dive deep into this, because the math is good fun, but I’ll offer a quick example below as well.

Once you get the compound interest machine cranking, your investments will generate you an income of their own relatively quickly without you having to do a single thing. For example, you might be aged 22 on what Statistics NZ says is the average weekly wage for a person aged between 20-24: $701. That’s a gross salary of $36,452. Let’s say you plug 15 percent of that - $5468 – into an investment that’s returning a long-term interest rate I’ll cautiously peg at 4 percent.

Using Sorted’s compounding interest calculator, we get these exciting results:

  • After five years: $26,825 of which $1,051 is compounding interest.
  • After 10 years: $53,855 of which $4,738 is compounding interest.
  • After 20 years: $109,578 of which $20,167 is compounding interest.

And let’s remember that this assumes you’ll never get any kind of pay rise or increase your savings rate. You might be thinking, ‘But I’m earning peanuts now – I’ll put this off until I’m older, when my paycheck’s looking healthier and I’ve stopped spending so much on Uber Eats.” This is a mistake.

Let’s fast-forward to the future. You’re now 42 and earning the pre-tax weekly average of $1318, giving you a yearly 15 percent investment goal of $10,280. After 20 years of compound interest on that, you’re 62 and your nest egg has turned into a lovely-sounding $206,009, with $37,916 of it purely interest.

But there’s a problem: you frittered away the first 20 years of savings while waiting around to get started, and missed out on 20 years of investment returns. That’s a minimum of $109,578. If you hadn’t messed about, you’d now have $442,412 to retire on, and a whopping $161,197 of it would be compound interest.

The really dramatic effects of compound interest need time to get going. Getting started in your early 20s means you’ve got time on your side.

Note:

Kiwisaver is the easiest shortcut to investing there is. You can put up to 8 percent into Kiwisaver and completely forget about managing it, forever, but be aware of the restrictions around getting your funds back.

Fees, and the kind of fund you’re in, are worth paying attention to – Sorted has good tools to help you do that. Take Kiwisaver seriously even though it’s easy. The fees you’ll be reading about sound very low – 3 percent, 5 percent – but if you consider that 10 percent is considered an excellent profit, then that puts them in perspective. Fees are a huge deal over the lifetime of your investment so don’t let them eat up your earnings.

You should all be in ‘growth’ or ‘aggressive’ Kiwisaver funds unless you’re going to withdraw your funds for a house deposit within the next five years.

Another note:

If you have consumer debt, your best investment is paying off that debt as soon as possible because it’s a guaranteed return – after all, compounding interest can work against you as well as for you.

For example, if you’re currently paying 19 percent per annum on a $2000 credit card debt, it is certain that when you pay it off, you’ll have a minimum of $380 in your pocket that you otherwise wouldn’t have had. Also, never ever borrow money to invest in the stock market.

Index funds, also known as Exchange Traded Funds (ETFs)

Why invest in this instead of buying individual shares? The short answer: diversification and automation. Read on for the long answer.

Shares are risky. But understand that in finance, the relationship between risk and reward is very direct. Your savings account at the bank is safe, but it’s also low-reward, and as mentioned, inflation is eating what little return you get anyway.

Also, in finance, risk is quantifiable. If you dig into it, you can find a bunch of reliable formulas for calculating the relative risk of investing in a company based on data from its annual reports. Unless you like that kind of thing, all you really need to know is how much risk you’re personally comfortable with. There are all sorts of calculators for that online, or you can use Kiwisaver’s ‘Mind over money’ personality quiz.

Because you all have a lifetime to make up for the fall-out of any big disasters, the answer to how much risk you’re comfortable with should really be “A lot,” but you’ve got to be true to yourself here. Don’t try to go riskier than you want to or you could make bad mistakes via overcommitting and panicking.

Diversification spreads your risk across many different companies. It’s about putting your eggs in lots of different baskets. Index funds do this automatically. They are called index funds because they’re indexed to the performance of a particular market – the idea is that when the value of said market rises, that of your units does as well. The lowest-fee Smartshares package is indexed to the performance of the top 10 companies on the NZX.

Markets rise and fall, but over a long enough horizon, they will always rise (unless you are investing in an international market with very big problems). This is what economists are talking about when they discuss national “growth” – essentially, if the total market isn’t growing, the country is in a recession and everybody freaks out.

Because all the decisions regarding index funds’ investing are made by a computer, you also avoid paying any Jordan Belforts crazy money to be your fund manager. You’re not funding a research team, or any analysts, or a bunch of dinners out at Dorsia. There’s all sorts of studies showing that human fund managers don’t add anything useful over the long term. It’s impossible to beat the market consistently over the long term, so don’t try, and don’t pay anyone to try.

Happy life planning!

To summarise:

  • You need a safe place to put your money.
  • You should be investing about 15 percent of your income into something as soon as possible: start today.
  • Pay off your consumer debt if you have it!
  • Take Kiwisaver seriously even though it’s easy and simple.
  • Take the time to think about your risk tolerance and match your investment to it.
  • Don’t try to be the Wolf of Wall St.

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