Investing when you're young is always a great idea, because it allows you to take full advantage of the benefits of compounding, but it's doubly advantageous to start investing when the market has good upside potential. But that doesn't mean that just any investing is good investing. What follows is a basic, though not exhaustive, road map to help you avoid some common mistakes many new investors make.
Young investors have a big advantage over those who are closer to retirement: time. Investors with a long investment horizon can accommodate greater risk, and thus greater return potential, because there is adequate time to make up losses. The risk, then, is investing in securities that are too conservative and that don't have the potential to substantially outpace inflation over time.
If you're looking at the investments that have performed the best over the past three years, you might be inclined to stick with good old U.S. Treasuries or even a CD. From a risk standpoint it may seem prudent to do so, but it's more advantageous to strike a balance between risk and return potential through measured access to more aggressive asset classes, such as equities. You don't want to be in the position of not having saved enough.
Top fund shops such as T. Rowe Price and Vanguard have built their target-date lineups with this in mind. Both firms start their target date funds' equity stakes at 90% for investors who are furthest from retirement. (Currently, that applies to the 2050 and 2055 portfolios.) This means that these firms' asset-allocation committees, groups of highly experienced and successful investors who put a great deal of thought into this issue, are favoring stocks for younger investors.
Mistake #2: Disregarding Risk
The flip side of that coin is failing to pay enough attention to risk. It's easy to be tempted by investments that promise market-slaughtering returns, because in many cases and for short periods of time, those investments can deliver. People love to talk about outsized gains from niche investments like technology funds. (Remember those?) But stretches of explosive performance don't often last, and when these investments fall, they can fall hard.
Emerging-markets funds are a great recent example. This category's recent returns have been enticing, but the wide performance swings that characterize this asset class have been on display lately. From 2003 to 2007, the average emerging-markets fund gained more than 35%--a greater gain than that enjoyed by any other international-fund category, except for Latin America. Then, emerging-markets funds lost 54% in 2008 as the market indiscriminately shunned risk-prone investments. Now the category is up 60% through September 2009. Among international-fund categories, only Latin America funds are more volatile than emerging-markets funds, as measured by 15-year standard deviation.
