Hypothetical Henry Series: I'm Still Young, Why Invest?

Did you notice that the American consumers experienced a recent inflationary spiral? A cost-of-living increase that swirled from 1.4% in December 2020 to a peak of 9.1% in June 2022? It was painful. It might not have hit you too hard if you are young, unemployed, and not buying groceries yet. But if you were receiving a paycheck and deposited any unspent cash in a traditional bank savings account, you probably noticed how little your friendly banker was willing to reward you with interest on that money. Where am I going with this? If you allow savings (which isn’t an investment) to sit too long in a no- or low-interest-bearing account, inflation will surely devalue the worth of that hard-earned cash over time.

Izzy the Inflation Monster

Combating inflation is a primary reason to start saving early and often in life. Why? The higher the rate of inflation, the less your money will buy. But if you start early purchasing certificates of deposit (CDs) or money market funds, or carefully investing in stock, bonds or other short-term assets, you have the opportunity to allow those dollars to keep up with or hopefully outpace inflation.

In a blog written back in April 2020, I used a simple example to emphasize the destructive force of inflation on your purchasing power. In the example, I assumed that beginning at age 22, a wise young investor, hoping to save $1 million before retirement, opens a Roth IRA, uses a Bankrate Investment calculator to determine the amount of monthly savings ($367) needed to reach that goal, routinely invests the $367 in a Total Stock Market Index Fund yielding 6% over time, compounded quarterly, and retires at age 67. Without considering Izzy the Inflation Monster’s impact, after 45 years of routine saving, the plan produces the desired $1 million. Wow! One million bucks! Is the investor sitting pretty for a predicted 10-30 years of life in retirement, or what? Maybe…but not necessarily.

Using the same assumptions, but allowing for an inflation rate of 3%, let’s determine what the purchasing power of today’s dollars (the $1 million) will actually buy in 45 years. How about $265,000? WHAAAT!??? That’s right, toothy Izzy has a voracious appetite. At a more manageable inflation rate of 2%, the purchasing power would equate to $411,000. That’s why I call Izzy an Inflation Monster. That old boy will very likely take $1 million and gnaw off huge chunks in terms of purchasing power over time.

Early Choices

Of course, early on, you need to save for rent, transportation expenses and other necessities. A wise way to take care of necessary near-term expenditures is to consider an available array of shorter-term investments like money market mutual funds or higher-yield bank money market accounts for cash accumulation purposes, primary among them a low-risk place to store easily-accessible rainy day fund money. Higher risk investments like stocks and ETFs can come later (but don’t wait too long).

The front end of your investor experience is a good time to look inward – to evaluate yourself as a prospective investor. Yes, this is a challenging task for someone with minimal exposure to monetary risk taking, but it must be done and in a clear-eyed manner.

First and foremost, what is your tolerance for risk? Living 20 years or so of life has probably given you some idea of your own risk tolerance, but not necessarily in terms of exposure to financial risk…exposing YOUR limited financial resources to the vagaries of an often volatile market. This introspection is part and partial for developing personal short- and long-term goals: What you hope to achieve through both saving and investing.

In the final analysis, it boils down to whether you’re more comfortable being an active or passive investor. Sounds simple, but this determination is a really big deal. As an example, active investors are inclined to buy individual stocks requiring more time spent researching detailed company information; whereas, a passive investor might be more prone to invest in highly diversified mutual funds or ETFs.

Of note, studies – particularly involving those popular index funds – have revealed that a passive approach to investing tends to result in greater rewards than an active approach over time. This should be an attention-grabbing revelation for someone with minimal experience in investing or to someone who wishes not to spend an inordinate amount of time researching investment opportunities.

  "But, I'm Poor"

And about that excuse, “I don’t have any money to save and invest.” Well, to invest, it’s true you will need some extra cash, but you don’t need much in today’s world to get started. Most potential investors are probably up to speed on tools of the trade – iPhones, iPads, computers, etc. – or are quick studies thereof. Just know that many online brokers have no account minimums to get you started. Some even offer fractional share investments. So, it takes very little for young investors to purchase ETFs and/or index funds that enable them to build that valuable diversified portfolio of securities.

In short, “I don’t have any money” is a pitiful excuse not to save and invest in today’s hi-tech environment. We all have cash-draining million dollar habits. Solution: Just skip four or five Pumpkin Spice lattes each month or four packs of Missouri cigarettes (the cheapest in the country), and you suddenly have $20 to invest.

Hey, it’s a start.

Advisors Cost Money

By the way, if you take the passive route to investing, you don’t necessarily need help in choosing or managing your portfolio. Investing in an S&P 500 Index Fund or a Total Stock Market Index Fund allows you to “dare to be average” while taking immediate advantage of my "PDQ Principles of Investing": patience, diversification and quality. Index funds are high Quality, highly Diversified investments that you simply nourish with Patience.

Without question, a qualified financial advisor could be helpful at the outset, but advice costs money. An index fund that offers the foregoing PDQ advantages is without question the lowest cost approach to investing for beginners.

By the way, as you become a more sophisticated investor, keep in mind that as your success grows, so does your tax exposure…on interest, dividends and capital gains. Paying taxes on investment income is a nice problem to have, but you can reduce exposure to such taxable events by shifting some of your burgeoning skills to owning investments in tax-advantaged retirement accounts such as Roth and traditional IRAs. They have strings attached, of course, but such accounts make sense.

Why Mutual Funds?

I prefer mutual funds as those instruments best suited for new investors or for investors that prefer less time spent researching investment possibilities. A primary investment risk-reducer is diversification. Mutual funds simply allow the investor an opportunity to buy a highly-diversified basket of quality stocks (or bonds or other assets) as opposed to tediously building that basket on his or her  own.

For example, the S&P 500 Index is comprised of 500 or so of the largest companies in America. Granted you’re buying some “barkers," but you’re also buying a preponderance of the best companies in America. And, because index funds are essentially unmanaged, they come with very low annual operating costs, which means they are a great tool when building a nice nest egg.

In short, with mutual funds you keep more of your money up front, and you’re virtually guaranteed the market rate of return, which, over a work career, is a return better than most active investors earn. With the exception of 2022, the stock market has been very kind to S&P 500 Index Fund investors. Recent returns, including dividends from 2020 through 2025, have been: 18.4%, 28.71%, (18.11%), 26.29% and 25.02% respectively…16.06% on average. Over the last century, the S&P 500 rate of return has been negative in just 26 of those 100 years.

What are ETFs?

Exchange-traded funds have characteristics similar to mutual funds. They hold a basket of securities but are traded throughout the day like individual stocks. Active investors tend to prefer them over mutual funds due to those day-trading characteristics. And ETFs do not come with minimum investment requirement barriers. Mutual funds usually have such requirements, often several thousand dollars. ETFs can be purchased for the cost of one share plus fees. Both ETFs and mutual funds are important assets to hold in tax-advantaged accounts like 401(k)s and IRAs.

401(k)s and other Retirement Plans

If you happen to be employed by a company that offers a 401(k) plan, it is a very simple way to become an investor. In fact, many employers automatically enroll new employees in their plans. Of course you can unenroll if you desire, but most folks do not, particularly if the employer offers to match a portion of what you agree to save out of your paycheck. I call it “Free Money,” which is something most folks find hard to turn down.

There are two basic types of 401(k) plans:

• In a traditional plan, your contributions (and contributions on your behalf) are made prior to being taxed and grow tax-free until retirement.

• Some employers offer what’s called a Roth plan that allows after-tax contributions to be made so the investor won’t have to pay taxes on withdrawals during retirement.

The beauty of the 401(k) plan is that once you decide how you wish to invest your contributions, they become automatic, bringing consistency into play. A consistent investor tends to be a wise investor…one who doesn’t flush in a down market…who doesn’t try to time the market…who adds to his or her portfolio through thick and then.

In Sum

As a brand new investor, it's wise to do two things: Ponder your financial goals and, in a clear-eyed manner, ascertain your tolerance for risk. Both are very important considerations before making financial commitments to an array of investment opportunities with varying degrees of risk. These exercises will help determine whether you are to become an active or a passive investor and whether or not you wish to manage your own investment portfolio or seek help from the experts.

The important thing is to get involved early in your working life and stay involved. Most major market moves occur on surprisingly few trading days. It’s important that you be there.

Good luck.