Investment Advice for Gen Y

My kids are members of Gen Y.  They are 26, 25 and 21, and I am exceedingly proud of each of them.

Here is my best single piece of investment advice to them and to every member of Gen Y:  Start saving and investing early.  Einstein may never have said it (as claimed), but compound interest is a wonder of the world.  And anybody can take advantage of it — it’s utterly egalitarian.  If you do nothing else about your retirement, start saving early.  You should also save a lot (at least 15 percent) and stay out of debt, but I promised to stick to one.

Here’s all you need to take advantage of this sage wisdom:

  1. The brains to know what you’re doing and why;
  2. The commitment to keep at it; and
  3. Time.

That’s it.

Want proof ?  Since I strive always to be data-driven, here you go….

Suppose Ginny opened a Roth IRA at age 19 and for seven straight years she contributed only  $2,000 to it (she should save much more, of course) and achieved an average annual return of 10 percent (that’s very high for today’s markets, I know, but please make the assumption for the sake of the illustration). Let’s further suppose that after making these seven annual contributions, Ginny doesn’t put another nickel into her Roth IRA.

Now let’s suppose that Bob isn’t as smart as Ginny (an assumption that my kids will readily grant) and that he doesn’t open his Roth IRA until age 26 (the age at which Ginny quit making contributions). However, from that point on Bob makes $2,000 contributions each and every year through age 65 and gets the same 10 percent average return over that time.

Once you do the math, the results seem impossible. 

Ginny, who only made seven contributions ($14,000 total) but started earlier, ends up with more money at age 65 than Bob, who made 40 contributions ($80,000 total) but started later.  Bob ended up with $944,641, which isn’t bad for having made contributions totalling $80,000.  But Ginny ended up with $973,704, even though she made far fewer contributions totalling much less.  The key, of course, is that Ginny had seven more early years of compounding than Bob did. Those seven early years were worth more than all of Bob’s 33 additional contributions.  Because of time and the magic of compound interest, Ginny’s $14,000 turned into nearly $1 million.

If you don’t trust my math, you can do it yourself here.

If you take no other advice that I offer about saving and investing, please start early.  And whatever age you are, get started saving or save more immediately. Please. Time is of the essence.


15 thoughts on “Investment Advice for Gen Y

  1. I like to sprinkle a little personal finance into each lesson I give to my students, and use the same example (except Ginny contributes $10K/yr from age 25 to 35, and Bob contributes $10K/yr from age 35 to 65). I always get a stupified look from the class — I am never sure whether it is disbelief or disinterest (or perhaps boredom). In any case, it may be that 24-year olds are predisposed to feel invincible and they don’t want to hear about saving.

    • I think it is because contributing $10,000 annually to a retirement plan seems TOTALLY IMPOSSIBLE to most people, especially younger people who are not in peak earning years. Most people cannot come up with $200 on short notice. Financial types tend to think in rarefied air; don’t forget that the vast majority of people are blissful enough NOT to be burdened by concerns about what to do with their money. They will be justified by Social Security and Medicare, when the joke is on the monied folks who end up paying for it.

      • Bob got a late start because his first seven years surplus all went to paying off his student loans. Ginny’s parents had footed her college bill. The moral of this story: a small amount of student loan debt has pretty severe long term consequences.

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  4. I have always wondered how this example played out if it wouldn’t assume a flat 10% increase. I bet Bob would fare a lot better if we had regular bear markets b/c his dollar cost averaging will be larger, or maybe even if we’d only look at a more realistic 3-5% return after inflation (Bob contributes later, so he’s less affected by inflation)

    • I just replicated this quickly and came up with similar results, but 941K and 893K, so I must have slightly different structure to my equations. Anyways, at 5%, Bob passes Ginny around age 40 in my simple calculations. Bear markets will be offset by bull markets (who would have predicted the past 5 years of stellar returns?), though the timing of the ups & downs is always a risk for any investment, and not one we can predict very well (I think that past methods, which were long-range return estimates and reasonably accurate so far as they went, are losing some predictive capability because underlying market structure is changing.)

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