Most Americans are notoriously bad with money. And even those who are smart with their finances tend to wait until their 30s or 40s to get serious about value investing. But research shows that people who start in their teenage years are far likelier to build wealth and enjoy sustained success.
The Power of Compound Interest
Put simply, compound interest is beautiful. It’s been referred to as the most powerful force in the universe and has allowed millions of people with income to build extraordinary wealth throughout history.
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In the simplest terms, compound interest is the principle by which you can earn interest income on your interest income – creating a snowball effect that accelerates over time. In other words, if you have $1,000 and earn 10 percent interest, you end up with $1,100. If you make 10 percent on this money, you end up with $1,320. And while it takes a few years, the growth becomes exponential and eventually creates massive returns.
While saving money is important, it’s investing that really allows people to build wealth. Interest rates are key – and the earlier you start, the more you’re able to benefit from compound interest.
“For instance, a 20-year-old that invests $10,000 today and parks it in Treasury bills, earning 4% on average for the next 50 years, will find himself with $71,067 if the purchases were made through a tax-free account such as a Roth IRA,” financial advisor Joshua Kennon explains. “Had he invested in stocks and real estate, earning a 12% average rate of return over the same time, he would have ended up with $2,890,022. Adding higher returning asset classes would result in more than 40 times more money thanks to the power of compound interest.”
Beginning your investing as a teenager – as opposed to waiting until your 30s or 40s (like most people – allows you to accelerate your earnings and see massive returns sooner rather than later.
Smart Steps Teenagers Can Take
If you’re interested in reaping the rewards of compound interest, you’re probably wondering where to start. Here are sound investment tips and techniques crafted with the teenage investor in mind:
- Form Smart Financial Habits
Sound investing is the byproduct of smart financial behavior. Very rarely will you meet someone who is poor with managing personal finances, yet happens to be a good investor. And when you meet someone who is smart with personal finances, you’ll almost certainly be looking into the eyes of someone who understands the power of investing.
Your teenage years are the perfect time to begin carving out smart financial habits that set you up for success. For example, it’s the best time to begin building credit. Average length of credit is a significant factor in your credit score, and you can get a major boost by simply having your parents add you to their card. You’d also do well to learn about budgeting and saving.
- Don’t Throw Money at Risky Investments
If you’re open to the idea of investing, you’ll suddenly start to see opportunity all over the place. The problem is that many of these opportunities involve a high amount of risk. Instead of tossing money at some get-rich-quick investments – which rarely pan out – you’re better off using a conservative investment strategy that’s proven to work over many years. This means stocks, bonds, mutual funds, and the like.
- Open a Custodial Account (With Help)
If you’re under the age of 18, you’re going to need some help to get started investing. Federal guidelines prevent you from opening up your own investment account, but you can always have a parent assist you in setting up a custodial account. Under this setup, your parent acts as the custodian until you reach the age of majority (at which point you take over).
There are two major options with a custodial account: a custodial brokerage account, or a custodial Roth IRA. The latter can be used if you have earned income. The former can be used regardless.
- Make Regular Monthly Contributions
Investing isn’t about investing $10,000 here and $20,000 there. Instead, it’s about investing $100 or $200 per month over many decades (and increasing the size of your investments as you’re able). Commit to making regular monthly contributions, and you’ll enjoy the benefits of compound interest throughout your lifetime.
Investing From an Early Age
It takes sacrifice and discipline, but investing from an early age is one of the smartest things you can do. By the time you turn 30 or 35, you’ll already have a sizeable nest egg to your name, which will allow you to enjoy life and let your money do the work.