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3 tips for young investors

Smart moves early on can pay potentially big dividends down the road.

3 tips for young investors

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.

Freedom Funds Rolldown

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.
 

Hypothetical starting balance

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).

Start Early

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.
If you have access to a 401(k), 403(b), or 457 retirement savings plan and your employer offers a matching contribution, take advantage of it. The matching contribution is like getting "free" money.2 And you get the added potential benefits of any tax-deferred growth and compounding returns.
One caveat: If your employer's matching contribution is low (less than 50%) and you have credit card debt with an interest rate of more than 25%, paying down the debt typically makes the most sense.

2. Pay down high-interest debt.
If your interest rate is high on your credit card or other loans, more than 9% for example, use any extra savings to pay down the balance. If you have multiple accounts, you can work on the one with the highest interest rate first.

3. Contribute the maximum to your 401(k) or other workplace savings plan.
It may make sense to contribute the maximum to a workplace savings plan or other retirement accounts before tackling low-interest or tax-advantaged debt like a mortgage or low-interest student loan. That's because the amount you need to save for even basic expenses in retirement can be hundreds of thousands of dollars, or more. You don't want to be borrowing money for living expenses later. You may be able to contribute up to $16,500 to your 401(k) or other workplace savings account for 2011.

4. Fund an IRA.
When you've maxed out your 401(k), consider other investment choices such as a Roth IRA. If you don't qualify for one because of your income, a traditional IRA might be another option.3 The annual IRA contribution limit for 2011 is $5,000. To make it easy, set up your IRA contributions to be automatic, as they are for 401(k)s.

5. Start working on other key goals.
Automatic investing plans can also work for other saving goals.4 Have a set amount of money transferred each month into an investment account from your bank or paycheck to help you save money for a down payment on a home, fund a child’s education, or whatever your goals may be.

Next steps


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.

Portfolio Review is an educational tool.

Past performance is no guarantee of future results.

Diversification/asset allocation does not ensure a profit or guarantee against loss.

1. This hypothetical example assumes the following over 35 years: (1) one annual $5,000 IRA contribution made on January 1 of the first year, (2) annual rate of return of 7%, and (3) no taxes on any earnings within the IRA. The ending values do not reflect taxes, fees, or inflation. If they did, amounts would be lower. Earnings and pre-tax (deductible) contributions from a Traditional IRA are subject to taxes when withdrawn. Earnings distributed from Roth IRAs are income tax-free provided certain requirements are met. IRA distributions before age 59½ may also be subject to a 10% penalty.

2. Employer contributions are subject to your plan provisions.Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

3. Anyone with employment compensation can contribute to a Roth IRA, subject to the following income limits. For single filers: Up to $107,000 in 2011 ($107,000 to $122,000 in 2011 for a partial contribution in 2010). For joint filers: Up to $167,000 in 2010 and $169,000 in 2011 ($167,000–$177,000 for a partial contribution in 2011). You must be at least 18 years old to open an IRA with Fidelity.

4. Automatic investment plans do not assure a profit or protect against a loss in declining markets.

Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

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