A Millennial's Guide To Money And Long Term Investing

by: Ivan K. Wu

The biggest challenge facing millennials today is not a lack of investment knowledge, but the lack of a framework to think through investment decisions.

Money and long-term investing can only get you where you want to go if you know where you’re going.

For the average investor, a defensive strategy should deliver adequate returns with minimum upkeep.

For a long-term investor, the biggest risk is you and the greatest errors are always unforced.

The Young Professional's Dilemma

I've often been reluctant to hand out investment advice for two reasons:

  1. I'm too inexperienced to know what I don't know
  2. I'm skeptical of any hard and fast rules to investing and personal finance

Over the years however, I've realized that there are issues facing millennials that deserve to be addressed. They say that youth is wasted on the young. This seems especially true in financial matters. It's one of life's great ironies that when opportunities are at their most abundant, we're the least equipped to take advantage of them. In the age of information, the biggest challenge facing young professionals today is not a lack of investment knowledge, but the lack of a framework to think through investment decisions.

Deep down, most millennials sense this feeling of something slipping away. The fortunate ones have been working steady jobs for 3-5 years. Perhaps they've even set aside some savings. They're thinking about spending on travel, on a wedding or on a mortgage down-payment, but are worried that the time to invest is now. They start browsing Seeking Alpha and buying a few shares of Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL) or Tesla (NASDAQ:TSLA). At the heart of it all is the young professional's dilemma: the constant struggle between the things they want and the things that are expected of them.

The Name of the Game

Money. Life's too short to have to think about it all the time, and the reason you think about it is because you don't know what you want, and have to settle for just making more. You know -- just in case; until you figure it out.

If you go back to first principles, money is just a series of options. You can exercise these options today by spending it, or you can invest it in exchange for future goods and services. Money is worth more the longer you defer spending, and the longer your runway, the more valuable an invested dollar is. Your runway is the longest in your 20s: about 30 to 40 years.

Given the stakes, it's important to set clear goals about what you want. The goal is not to be rich. Rich doesn't exist. There's no magical barrier you can cross. And since people experience life in relation to other things, rich will always be a moving target, because there's always the next thing to compare yourself to. Like a starving man fantasizing about unlimited quantities of food, scarcity blinds us from figuring out how much we actually need.

A Minimally Satisfactory Life

A genie comes up to you one day and tells you that if you can name a sum of money, she can guarantee that you'll get that sum every year until you turn 65. There's a catch, of course: You have to give her the lowest possible number that you'd be satisfied with.

So, what's your number?

I can't do the math for you, but you can break the question down into two parts:

  1. What's the minimum amount I'd be satisfied in spending each year? Factor in housing, food, entertainment, travel, future kids and inflation. Also factor in an annual emergency fund for things like family, health, repairs and stupid decisions.
  2. What's the minimum amount I need to save by the time I turn 65?

The 'minimum' part can't be stressed enough. Instead of chasing 'rich,' find out what your baseline is. How much do you actually need?

Your answer to the first question yields your minimally satisfactory salary.

Your answer to the second question requires a bit of back-of-the-envelope math. For the sake of argument, let's say you need one million dollars by the time you're 65 (you don't). The Rule of 72 estimates how long it would take for your money to double. The historical nominal annual return of the S&P 500 is 6%, which means it takes roughly 12 years to double your money (72 divided by 6).

After 36 years, your money will be worth roughly eight times more. When you're 29 years old, you have exactly 36 years to 65. This means that if you and your partner have at least $125,000 invested in a low fee U.S. index fund before you hit 30, you'll have roughly 1 million dollars by the time you hit 65.

Now divide 125,000 by the number of years before you hit 30, then add that annual number to your minimum salary. This is the number that funds your minimally satisfactory life. Does this sound depressing? It shouldn't. It's liberating to have a tangible, achievable goal. A barrier you can actually cross. And when life is short and time is limited, crossing that barrier means you have time to focus on the things you actually want. Crossing that barrier means that you can no longer be bought.

Setting up the Board

Investing for the long term means you have money you can afford to forget about for 30+ years.

By that logic, you're not ready to be a long-term investor if:

  1. You're in debt. If money represents options, debt diminishes your options at a rate compounded annually
  2. You don't have at least six months worth of emergency funds in your savings account
  3. You haven't maxed out your 401(k) employer match and Roth IRA retirement accounts

I'll address the third point briefly. As an investor in your 20s with a 30-year runway, there is little reason why your retirement account shouldn't be composed of mainly stocks tracking a U.S. index like the S&P 500.

Throughout recorded history, the returns of the stock market have consistently outperformed other asset classes, even during turbulent periods. Take the past 30 years for example. If you had invested in a low-cost S&P index fund on January 1995 and held onto it through the dot-com bust and the Great Recession, your investment would've quadrupled in value. Volatility smooths out over the long term. Index funds should be purchased the same way as everyday essentials: consistently, month by month, buying more when there's a bargain, less when there isn't, and never selling in panic.

The Defensive Strategy to Long-Term Investing

In sports, they say that offense wins games and defense wins championships. This extends to investment strategy as well. Believe it or not, there is a no-lose solution to long-term investing, and executing that strategy means plowing all your monthly savings set aside for investing into U.S. index funds, in the same manner described previously.

Why U.S. index funds specifically? The reason behind this has less to do with patriotism than demographics. The chart below displays the median age by country:

Source: Wikipedia

The U.S. has the most favorable demographics out of all developed countries, with the regulatory and economic system in place to capitalize on that advantage. As competitive advantages go, having an Ivy League and a Silicon Valley ranks high on the list. If replicating these advantages were so easy, other countries wouldn't still be talking about trying to replicate them. Over the long term, there continues to be no surer bet on the future than the American economy.

For the majority of young professionals with only a passing interest in finance, the defensive strategy works and should deliver adequate returns, with minimal risk to principal over the long term. To drive home the defensive advantage, consider this: In any given year, about 50% of mutual fund managers fail to beat the return of the S&P 500. These are people who have devoted their lives to the investment profession.

What makes you think that you'll do better?

The Aggressive Strategy

For those who believe that they've been endowed with either unconventional ability or insight, and are ready to put in the hours to comb through annual reports, test out their hypotheses and to constantly seek out critical feedback, then the aggressive strategy has the potential to deliver exceptional returns.

In a nutshell, the aggressive strategy involves three steps:

  1. Formulating hypotheses on individual stocks based on cogent, long-term economic reasoning
  2. Rigorously testing your hypotheses through research, logic and peer review
  3. Ensuring that a stock is purchased at the right price

Oftentimes, the right stock has to be all of the above and unpopular with your average investor. The reason for this is simple: if the price of a stock is determined by past performance and future expectations, the more popular a stock is, the higher future expectations are. And the higher the expectations, the harder it becomes for a company to meet them. Sooner or later, the price of a stock will eventually correct itself downward to meet reality. This could happen tomorrow, or months or years from now, and often involves a negative catalyst that changes public opinion. When you ride the wave of irrational exuberance, you always run the risk of being the last sucker at the table.

Our Animal Instincts

At NASA, there's a saying that in space, there's no problem so bad that you can't make worse. Consider the investors who cashed out during the panic of 2008-2009 to "seek safety," at a time when stocks were holding one of the greatest bargains this side of the Great Depression. Over the long term, stocks are only as risky as your response to it. With a long-term horizon, volatility becomes your friend.

Yet looking around, it seems as if nobody wants to get rich slowly. Some prefer the thrill of uncertainty to the patient, unerring accumulation of wealth. Long-term investing at its finest should be all of the above: clinical, automatic and boring.

The greatest enemy to the long-term investor is the animal instincts of panic, anger, greed and irrational hope, all of which are far removed from fundamental realities.

You can see the animal instincts at work in the primaries leading up to the 2016 U.S. elections. Without naming names, you can see which candidates appeal to anger, to panic, to irrational hope. For young investors just starting out on their journey, it's important to understand that there's no such thing as a "status quo" when everything is always changing. And over the long term, change is fundamentally biased towards progress.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.