Beware of the age/risk trap. Young investors are told that they can afford to take higher risks when investing their money. The reasoning behind this advice is that if they lose money on an investment, they still have time to recover the loss. This statement is partly true: the principal lost in an investment may be replaced over time. However, the time lost can never be replaced, and time is the main advantage of youth. Young people may not be able to save a lot of money, but what they can save has a lot of time to grow.
Consider this: At age 25, $504 per month saved at 6 percent interest compounded quarterly will yield $500,000 by age 55. If five years are lost, it will take a return of 8.4 percent on $504 per month to yield $500,000 by age 55. The five years lost translates into the need for a 40 percent higher return on the same monthly investment in order to achieve the same result. An investment with such an increase in potential return necessarily carries a proportional increase in risk.
Electing high risk investments at a young age could force an investor into accepting high risk investments later in life when there is less time to recoup losses. Rather than risk their savings and a loss of precious time, young people would be prudent to consider safe investments (investments that guarantee the principal and a minimum rate of return), accept a modest gain on their money and take advantage of time and compounding to make their fortunes.
Copyright 2010 K.C. Knouse
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages