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3 tips for young investors
Smart moves early on can pay potentially big dividends down the road.
George Bernard Shaw once said, “Youth is wasted on the young.” But that doesn’t have to be the case, at least when it comes to your financial life. In matters of financial planning, being young has big implications and huge advantages for the people who make smart decisions.
Here are three tips that young investors should know.
You may be able to take on more risk
Imagine you have been saving for retirement for 35 years, and you are planning to use that savings to pay your bills next year. What would happen if your investments lost a significant chunk of their value? It might force you to change your lifestyle. But what if you were just starting to save and didn’t need to touch the money for 35 more years? Chances are a dip in value wouldn’t impact you in the short-term and, over time the market might not only recover, but could move higher before you need to access your savings.
When you select a mix of stocks, bonds, and cash, part of the decision you have to make is how much risk—the chances that the value of your investments will go up or down—you can tolerate. If you are saving for retirement and have decades before you stop working, you may be able to take on more investment risk as part of your diversified portfolio.
But why would you want to take on risk? Well, while stocks historically, have been more volatile than bonds or cash, they have also historically delivered larger returns. As a younger person you may be able to better tolerate that volatility than an older person. After all, you have time on your side. So, while past performance is no guarantee of the future, that time gives you more opportunity to cash in on stocks’ potential for growth.
“We believe investors with long time horizons who plan on making consistent contributions have greater risk capacity,” says Chris Sharpe, a manager of the Fidelity Freedom Funds. Target-date funds, such as the Freedom Funds, provide examples of how a younger investor might take on more risk. Freedom Funds are designed for investors expecting to retire around a given year—for instance; investors in the Freedom 2055 Fund expect to retire in the year 2055. The funds invest in a diverse portfolio of stocks, bond, and other investments. As such, the money invested is never guaranteed and the investments are subject to the volatility of the financial markets, including equity and fixed income investments in the U.S. and abroad, and may be subject to risks associated with investing in high yield, small cap, commodity-linked and foreign securities. So, in an attempt to manage risk, the funds’ asset allocation strategy starts out more aggressive, and becomes increasingly conservative as it approaches the target date, and beyond. As investment mix changes, the investment risks of each Fidelity Freedom Fund can change.
To see how the Freedom Funds put this theory to work, look at how the asset mixes adjust in the graphic below depending on the number of years until the target retirement date, or the length of time that has passed since the target date. You can see how the funds reduce their stock allocation—and risk levels—as the target date approaches.
Savings made when you are young have more time to work for you
Starting young also means having more time for your investments to be in the market and potentially grow. That puts the power of compounding on your side, and compounding can be powerful.
Let’s look at a simple hypothetical example of how compounding works. In this example, we will see how $200 grows with a 7% return that compounds each year.
Over time compounding can have a major impact on your savings. Let’s say a hypothetical investor was trying to save $50,000 retirement. That person could save $50,000 from income in the year of retirement, or put $5,000 away 35 years before retirement, assuming 7% compound returns.1 With compounding, those $5,000 annual contributions can add up (see chart below).
The bottom line: Starting on the right path when you are young, can help put you in a position to choose the kind of lifestyle and experiences you want to enjoy later on. In fact, with the time on your side, achieving your goals through slow and steady saving may be within reach.
Make a plan to get ahead
High interest credit cards or high interest rate loans on student debt may need to be paid off before you prioritize long-term savings. That’s because it doesn’t make sense to try to save if your debts are growing faster than your money might. On the other hand, make sure you take advantage of the potential tax benefits and any company match available in a retirement account.
So what should you do to best achieve your financial goals? Here’s a prioritization strategy we think you may want to consider.
1 . Contribute up to the match to your 401(k), or other workplace savings plan.
2. Pay down high-interest debt.
3. Contribute the maximum to your 401(k) or other workplace savings plan.
4. Fund an IRA.
5. Start working on other key goals.
Before investing in any mutual fund, please carefully consider the investment objectives, risks, charges, and expenses. For this and other information, call or write Fidelity for a free prospectus or, if available, a summary prospectus. Read it carefully before you invest.
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. These risks may be more pronounced in emerging markets, which may be subject to greater social, economic, regulatory, and political uncertainties.
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