01 Jun Investing at 21. It’s not supposed to be Black Jack
The best way to start investing when you are 21 is to avoid mistakes. This might sound odd. Afterall, you are young, right? You have time to recover from a few mistakes. You can take a flyer on a micro-cap or aggressive short. Actually, there is plenty of evidence (and math) showing how small mistakes compounded over years to cost young investors 100,000’s of dollars. Here’s what I believe are some mistakes you can avoid.
Mistake #1: Trusting authorities
The investment advisor world is full of ‘rent seekers’ and you are the ‘renter’. They will let you invest in products that aren’t necessarily in your best interest.
- Case in point, mutual funds. In Vancouver, where I live, the average person pays 7-10x the hydro bill every month in fees to a mutual fund. Yet there are legions of financial advisors that exclusively sell mutual funds. They then get paid in commission or a “trailer fee” every year you stay with the fund.
- In the U.S., the recent DOL Fiduciary Ruling helps protect retirement accounts from hidden fees. There is no such protection for young investors. But there are plenty of hidden fees.
- Getting talked into taking unnecessary leverage. Young professionals might not have ready cash to invest–but they have credit. Some advisors suggest you out a line of credit to invest in stocks. Afterall, the stock market is expected to return 10% in the long-run– so by borrowing at 5% you can clear 5%, right? That advice so horrible I don’t even know where to begin. Advisors like this fail to account for the individual’s risk tolerance. Or the fact that stock returns exhibit heavy tails.
Mistake #2: Trusting your financial plan
Every software out there runs some variant of a Monte Carlo simulation– they makes some critically false assumptions. First, it assumes your portfolio’s volatility doesn’t change. In 2008, a balanced portfolio saw its volatility quintuple! Even the most risk tolerant people cannot stomach that. A diversified portfolio isn’t enough. You need a risk managed portfolio that gives you a steady volatility for any financial plan to work.
Mistake #3: Not buying bonds
Just because you are 21 doesn’t mean you should be 100% invested in stocks or alternatives! Will you need the cash to travel? To buy a home? If so, the invested cash should actually be invested very conservatively. It’s called goal-based planning. Google it. Also, a risk managed, diversified portfolio with stuff like high-yield bonds, preferred stocks, government bonds can lower your portfolio volatility without giving up return.
Mistake #4: Buying stocks you understand
Many people are inspired by Peter Lynch’s advice of buying what you know. The truth is, most of us know way too little about a company to earn consistent alpha from such a strategy. You stand to lose too much if you’re wrong. Still picking stocks? You’re doing it wrong.
Mistake #5: Buying penny stocks
It’s not that they’re risky. It’s fine if you hold 90% bonds and 10% in penny stocks. The problem with pink sheet or penny stocks is that they are often manipulated by pump and dump schemes. See “The Wolf of Wall Street”. If you still love penny stocks, set aside some play money in your Roth IRA or TFSA where you won’t be taxed.