Time Is on the Side of the Young Investor: Taking Risks Can Pay Off

Listen, I'm all in favor of limiting your losses when investing -- but the reality is that time is on your side as a younger investor. You need to use this weapon to your advantage while you have it.
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401k box full of paper money
401k box full of paper money

To all of you recent grads who just entered the workforce, here's some advice: Don't ask mom and dad for advice about retirement.

You may think they know everything, but after living through (and perhaps even contributing to) the dot-com asset bubble and the mortgage meltdown, your parents have probably screwed up their own retirement plans. Why would you let them screw up yours, too?

The biggest damage mom and dad perpetrate on young investors manifests itself in the key retirement vehicle of all workers -- the 401(k).

I sit on the 401(k) board for my small company now and we just had our annual wrap-up meeting. In it, I was amazed to see that the 21 workers under 30 years old at my company collectively have a larger portion of their 401(k) funds in fixed income than any other age bracket. That includes the six participants in the company who are over age 60. And some younger folks have 100 percent of their investments in low-yield, low-risk bond funds!

This is silly to me, but it oddly makes sense. After all, who are they asking for advice? Their aging parents ... who probably have been burned before, are probably getting defensive due to their age and are probably quick to warn against the false promise of getting overweight in equities.

Listen, I'm all in favor of limiting your losses when investing -- but the reality is that time is on your side as a younger investor. You need to use this weapon to your advantage while you have it.

Otherwise you will find yourself in your late 40s, behind on your savings and taking undue risks to catch up.

In other words, you'll wind up exactly where your parents probably are ... but for very different reasons.

The advantage of taking bigger risks when you're younger is twofold.

First, you have the rest of your life to recover any losses -- unlike big risks taken in your 50s that will wipe out a larger dollar amount from your portfolio and leave you will less time to recoup those losses. Put bluntly, would you rather see your $5,000 portfolio go to $2,500 at 28 or a $500,000 portfolio go to $250,000 at 58?

Secondly, the power of compound interest over time means that any gains made early on multiply exponentially over the next 30 years, so it pays to get aggressive. Consider that a $5,000 nest egg invested with a 5 percent rate of return for 30 years will turn into $21,600 or so, while a $10,000 nest egg invested with that same 5 percent rate of return for the same 30 years turns into $43,200. A difference in $5,000 on the front end results in an extra $21,600 on the back end... so spend your first few years growing your initial retirement fund as fast as you possibly can.

In short, the mistakes do less damage and the winners produce much bigger gains. So don't fall into the trap of being too conservative too soon.

Some young folks may simply be jaded by the markets, and I sympathize with that. But taking advice from parents in their 50s and 60s only feeds into the fear, pushing these young savers into capital preservation mode above all else.

There's nothing wrong with that mentality, but the sad reality is that most of us in our 30s don't have that much wiggle room. I personally have a mortgage, two kids in daycare, lingering student loan debt, car payments and many expenses I'm sure those in this season of life are familiar with.

Pushing aside 5 percent of my income each month for retirement is about all I can handle comfortably without living off of ramen noodles. If I want to get the "$1 million mark" by my 60s -- a general rule of thumb for a comfortable retirement, though even that figure is below what some folks may need given their lifestyle and life expectancy -- I have to put my money to work to get there.

So -- sorry, mom and dad. A high-interest savings account, Treasury bonds and investment-grade corporate bonds may be fine for you. But I am spending my early working life investing aggressively so I don't have to play catch-up later on in life.

Jeff Reeves is the editor of InvestorPlace.com and the author of "The Frugal Investor's Guide to Finding Great Stocks."Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.

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