Young, rich people are reportedly keeping a third of their wealth in cash but its not a strategy peers with decades of potential compound interest should mimic
It seems that young millionaires these days are being ultra-conservative with their investment portfolios.
Or at least thats what the results of the latest survey of the worlds wealthiest inhabitants, by Capgemini Consulting, suggest. According to its findings, millennial millionaires keep about a third of their riches in cash, whether its stacks of hundred-dollar bills kept in a safe, money in a savings or checking account, or near-cash equivalents.
Why? Well, it seems that when youre that wealthy, you want to be able to jump on new investment opportunities when they become available, such as the chance to buy shares in the next startup company before it becomes Facebook or Google.
When media outlets run stories about what super-rich investors are doing with their money, its often with a stated or unstated subtext: that there are lessons for the rest of us to draw from their behavior. Because, after all, if they are wealthy, they must be doing something right.
But when it comes to their personal finances, this couldnt possibly be more inaccurate. There are plenty of lessons that you can learn from wealthy people, but they dont involve mimicking their investment strategies.
While a millionaire millennial can afford to laugh off the mere idea of adhering to an asset allocation plan, the rest of us cant. And no one under the age of 40 should have a third of their wealth sitting idly in cash. Maybe a millionaire can afford to allow hundreds of thousands of dollars not earning its keep, but while its reasonable for us to keep an emergency cash cushion for emergencies, that shouldnt amount to a third of our total investment portfolios.
So how should a non-millionaire under 40 set about managing her money?
First and foremost, remember that you are in this for the long haul, so you cant afford to be spooked by short-term fluctuations in the market however big and scary they feel. Youve got decades literally to keep contributing savings to your retirement plan, and to allow the markets to recover from what feel like disasters at the time. Even people who began saving in the 1970s a notoriously dead time for investing ended up profiting when the bull market kicked off in the 1980s.
Remember, too, that you have this wonderful phenomenon known as compounding working on your side. Its a younger investors best friend. Every dollar that you put aside earns investment gains and/or interest income. If you dont sell it or pocket that income, that income then earns income in its turn. Its an incredible virtuous circle.
Heres an example. Lets say that you put only $1,000 into your 401(k) today and left it untouched for 30 years, during which it earned an average of 4% a year a fairly modest return. At the end of that period, youd have $3,243. If you invest an additional $1,000 a year, youd have $61,572. If you can invest $1,000 every three months? Well, it jumps to $233,164. All thanks to compounding. You dont need to take much risk to do very well indeed just start early and be disciplined.
An asset allocation plan, and not which stocks or mutual funds you choose, is the bedrock of your investment strategy. Over generations, stocks have outperformed for the long-term by which I mean decades, and if youre a millennial, thats the time frame you have at your disposal.
Virtually all experts agree you should put as much of your portfolio into stocks as you are comfortable with, as one slice of that allocation. Yes, its going to be the most risky and volatile piece of the puzzle, but history suggests that it also will be the piece that will earn you the biggest returns, so take a deep breath, remember that this a 30-year project, and go for it.
Certainly, the outlook for bonds which generate pretty much nothing in the way of income right now, and which are likely to be just as volatile going forward, given the world economic situation isnt any more encouraging. That being said, youll want to have some of those in your asset allocation, too, because they can serve as a safe haven.
Then theres cash, which should make up as small a piece of your portfolio as possible. Youll want to keep an emergency cash reserve on hand, of course, in case of unexpected medical expenses or a job loss. But otherwise cash which doesnt generate a return doesnt do anything for you. Unlike your millionaire buddies, you cant afford idle money. Make it work for its keep.
Within each of those broad categories, there are all kinds of investment possibilities, and here is where life gets a bit more complicated. Bonds and stocks come in all kinds of flavors, from sector funds to emerging markets; from junk bonds to corporate bonds.
My recommendation for the typical millennial investor, without the resources of a millionaire or a longstanding interest in financial markets, is to look for the most inexpensive and diversified investment stock and bond funds that you can find, and get exposure to a little bit of everything, because you just dont know when emerging markets, mining companies or even oil are going to rebound. (With a caveat, of course, that if youve got philosophical objections to investing in the latter two, youll want to find a socially responsible index fund instead, and may need to make the tradeoff of a bit more volatility or slightly higher fees, or potential financial underperformance.) Check out the fees, and keep them as low as possible below 0.4% for an index fund is de rigueur.
Millennial millionaires can draw on a lot of professional help if they choose to do so. The rest of us? Not so much. But its worth checking out the new robo-advisers, especially if youve begun to accumulate assets. Many of them use these commonsense approaches to investing passive portfolios based on index funds and automatic rebalancing to make sure a client sticks to his asset allocation.
You may never join the ranks of millionaires, but as long as you dont mimic their investment strategy, you can at least avoid making mistakes and make the most of the money that you do have over the long term. In this case, imitation may be the most foolish kind of investment strategy imaginable.
Read more: http://www.theguardian.com/us