Avoiding Big Investment Mistakes Early On
[dropcap background=”” color=”” circle=”0″]W[/dropcap]hile it’s great that you’ve decided to start investing at a young age, it’s also essential that you avoid some especially big mistakes early on. Some mistakes may be considered part of the learning curve, but you don’t want to make unnecessary ones that can cripple your financial future.
Early Mistakes in Perspective
One thing that’s important to understand is how much money you’re working with when you’re younger. We’re not talking about strict dollars and cents here, but rather the relative costs of the money you’re using. Due to compound interest and other factors, the money you invest in your 20s is worth a lot more than the same amount invested in your 60s.
To put this another way, suffering a $1,000 loss when you’re 25 is equivalent to losing $10,000 when you’re 60. Hopefully, this helps you better understand why you need to be so careful with your investments when you first start out.
Exponential Growth
Let’s now dig into this a bit deeper. Compound interest is when you reinvest your earnings from a certain amount of capital. Year after year, this amount builds up, providing you with exponential growth. Starting with just a $500 investment, for example, can reap you thousands and thousands in returns on your way to retirement.
However, this is also why you need to be so careful when you’re handling your own funds. Let’s say you invested $10,000 at age 30, receiving returns of 9%. By the time you were 60, this would mean over $130,000 waiting for you.
After five years, though, let’s pretend you made a mistake with your investment and it cost you 30% of your money. Then five years after that, you did it again.
Sadly, those two simple mistakes would lose you half of your money. Now, at age 60, you only have $65,000 to look forward to.
Three Different Investment Scenarios
If you contribute equal amounts over the course of 30 years, those first 15 will be three times as valuable as the next half to come.
Say you invest $6,000 every year for 30 years, with a return of 8%. In total, that would represent an investment of $180,000, which would yield you $707,000 at the end of those three decades or a return of 293%.
Now, say you didn’t invest that money until the second 15 years. You still invested $180,000, you just didn’t do it for 30 years. In that scenario, your investment would only be worth $339,000 or an 88% return above the amount contributed.
Lastly, let’s pretend you took the same amount of money, but invested it $12,000 at a time for the first 15 years and then didn’t add anymore. In that case, you’d now have a 497% return above the amount contributed for an ending sum of $1,075,000.
Psychological Effects
This only tells half the story though. There are also psychological effects associated with losing money that can be especially devastating on someone new to the field.
In 1979, Nobel Prize-winning psychologists Daniel Kahneman and Amos Tversky found that U.S. investors felt the pain of loss up to 2.5 times as intensely as they felt the pleasure of a gain. Losing 10% of your money, then, brings with it the same emotional intensity as a 25% return. If you are not the type that likes to read academic papers I can highly recommend Kahneman’s book Thinking, Fast and Slow where he in chapter 26 elaborates on this topic.
A myriad of research has been done to complement these ideas. A conclusion that can be drawn from just about all of them is that our brains are biologically unsuited for investing. They experience intense highs and lows and constantly look for patterns to act on, even when data is compiled randomly.
This doesn’t mean you have to give up on investing though. It means that you need to keep an objective, controlled mind. Beginning with investing early is important, but so too is avoiding big mistakes during this time.