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I've heard people suggest (here and in other forums) that you should be willing to take more risks when you are young. Can someone explain what "risky" options are being referred to?

I only have about a couple thousand (after thoroughly taking care of everything else such as emergency fund, future utility bills, transportation) with me, but would like to start investing ASAP for retirement. I have yet to graduate from college but I'll most likely be going to graduate school right after, so any near-future income (if any) will be very minimal. I will have my first official "earned part-time income" (also very minimal) in the spring when my university calls me in for a semester-long job.

I was wondering why "going risky" would be a better (and wiser) decision than putting everything I have into a mutual fund or ETF?

  • Mutual funds or ETFs can be risky. They are not necessarily safer or more conservative. – Chris W. Rea Dec 26 '11 at 2:16
  • So in Dark Templar's scenario, which it seems like he'll be investing in a 60+ year time-frame, would it really be better to go with the riskier/higher-return funds and ETFs? – Kaitlyn Mcmordie Dec 26 '11 at 17:30
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Why it is good to be risky

The reason why it is good to be risky is because risky investments can result in higher returns on your money. The problem with being risky, is there is a chance you can lose money. However, in the long term you can usually benefit from higher returns even if you have a few slip ups. Let me show you an example:

enter image description here

These two lines are based off of placing $2,000 in a retirement fund at age of 20 and then at age of 25 start investing $6,500 a year (based off of a salary of $65,000 with a company that will 1 to 1 match up to 5% IRA contribution, presumably someone with a Master's should be able to get this) and then being able to increase your contribution amount by $150 a year as your salary begins to increase as well.

The blue line assumes that all of this money that you are putting in a retirement account has a fixed 3% interest (compounded yearly for simplicity sake) every year until you retire.

The red line is earning a 12% interest rate while you are 20 years old and then decreasing by 0.5% per year until you retire. Since this is using more risky investments when you are younger, I have even gone ahead and included losing 20% of your money when you are 24, another 20% when you are 29, and then again another 20% when you are 34.

As you can see, even with losing 20% of your money 3 different times, you still end up with more money then you would have had if you stuck with a more conservative investment plan. If I change this to 50% each 3 times, you will still come out about equal to a more conservative investment. Now, I do have these 3 loses placed at a younger age when there is less to lose, but this is to be expected since you are being more risky when you are young. When you are closer to retirement you have less of a chance of losing money since you will be investing more conservatively.

Why it is OK to be risky when you are young but not old

Lets say you loose 20% of your $2,000 when you are young, you have 30-40 years to make that back. That's roughly $1 a month extra that you are having to come up with. So, if you have a risky investment go bad when you are young, you have plenty of time to account for it before you retire.

Now lets say you have $1,000,000 when you are 5 years from retiring and loose 20% of it, you have to come up with an extra $3,333 a month if you want to retire on time. So, if you have a risky investment go bad when you are close to retiring, you will most likely have to work for many more years just to be able to recover from your loses.

What to invest in

This is a little bit more difficult question to answer. If there was one "right" way to invest your money, every one would be doing that one "right" way and would result in it not turning out to be that good of investment. What you need to do is come up with a plan for yourself. My biggest advice that I can give is to be careful with fees. Some places will charge a fixed dollar amount per trade, while others might charge a fixed dollar amount per month, while even others might charge a percentage of your investment. With only having $2,000 to invest, a large fee might make it difficult to make money.

  • Wow. Just curious, but I had a couple more questions to ask (it would be nice if this let me insert some spacing, but unfortunately it won't): (1) I got the impression from some users that a mutual fund would be a better idea than ETF for someone who has minimal investments and don't make a stable income at early age. From a long-term standpoint though, does it really matter which one you go with? (2) Also is the 12% figure you came up with just an arbitrary number, or is it commonly used as a "within-the-ballpark" investment? Overall I really enjoyed this post. Thank you so much! :) – onaboat Dec 27 '11 at 23:37
  • I believe most mutual funds will allow you to perform a dividend reinvestment, which is what you will want to get that compounding interests. While I believe it can be more difficult to get ETFs to do this (however, I am not expert on this). I would recommend looking at some specific examples of what you have available and see what is best for you. As for the 12% figure, that is just an arbitrary number that I came up with. It is typically what I see in my investments, but I also have had a few go very bad. – Kellenjb Dec 28 '11 at 17:11
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First of all, "going risky" doesn't mean driving to Las Vegas and playing roulette. The real meaning is that you can afford higher risk/return ratio compared to a person who will retire in the following ten years. Higher return is very important since time works for you and even several extra percent annually will make a big difference in the long run because of compound interest effect. The key is that this requires the investment to not be too risky - if you invest in a single venture and it fails you lose all the money and that's worse that some conservative investment that could yield minimum income. So you still need the investment to be relatively safe.

Next, as user Chris W. Rea mentions in the comment funds and ETFs can be very risky - depending on the investment policy they can invest into some very risky ventures or into some specific industry and that poses more risk that investing into "blue chips" for example. So a fund or an ETF can be a good fit for you if you choose a right one.

  • Same as my comment on Chris's. Is it better to go with the higher-risk/return mutual funds and ETFs if you are looking at very-long term retirement investment? I was just curious as to when "risky" becomes "too risky", etc? – Kaitlyn Mcmordie Dec 26 '11 at 17:34
  • @Kaitlyn Mcmordie: Usual restictions apply: indiversified investments are too risky, investing credit money is too risky, etc. Other than that it's a personal decision - the investment can be more or less risky, one decides which one is okay for him. Again, mutual funds and ETFs can invest in super-reliable bods and bear minimal risk or they can invest in some venture companies and be much more risky. – sharptooth Dec 27 '11 at 6:42
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Those who say a person should invest in riskier assets when young are those who equate higher returns with higher risk. I would argue that any investment you do not understand is risky and allows you to lose money at a more rapid rate than someone who understands the investment. The way to reduce risk is to learn about what you want to invest in before you invest in it. Learning afterward can be a very expensive proposition, possibly costing you your retirement. Warren Buffet told the story on Bloomberg Radio in late 2013 of how he read everything in his local library on investing as a teenager and when his family moved to Washington he realized he had the entire Library of Congress at his disposal. One of Mr. Buffett's famous quotes when asked why he doesn't invest in the tech sector was: "I don't invest in what I do not understand.".

There are several major asset classes: Paper (stocks, bonds, mutual funds, currency), Commodities (silver, gold, oil), Businesses (creation, purchase or partnership as opposed to common stock ownership) and Real Estate (rental properties, flips, land development). Pick one that interests you and learn everything about it that you can before investing. This will allow you to minimize and mitigate risks while increasing the rewards.

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