The Top 6 Mistakes Young Investors Make

The Top 6 Mistakes Young Investors Make

Being an advisor catering to the younger professional I’ve seen the full spectrum when it comes to personal financial situations.  Some clients will have their financial lives in perfect order from the moment they walk in.  We just make a minor tweak here, a minor adjustment there and check in again in a few months

Others well… let’s just say there can be some room for improvement.  But hey, that’s what I’m here for.

I’ve noticed a pattern for these “areas of improvement” that keep coming up when people see me.  So I’ve decided to share those with you in hopes that you can have a head start.

So without further ado, I give you the top 6 mistakes I see young investors regularly make.. enjoy.

Mistake #1: Being afraid of investing and inevitable market downturns

Just as a cold beverage (beer, wine, strawberry spritzer) is your best friend after a long workday, time can be your best friend when it comes to investing.

Time typically allows you to weather the ups and downs of the stock market because you won’t need the money you’re investing until some date far off into the future.

So What, The Stock Market Crashed

Stock market plunged 20% this year?  Stock prices are dropping like rocks and everyone is panicking?

Perfect.  For the young investor with a long time horizon, you should be licking your chops.  When everyone is afraid of the stock market you should be itching to dive right in.

Market downturns can translate to opportunity for you.  If the stock market falls 20%, this is essentially a 20% discount in the price of stocks.  Would you be afraid of a 20% discount on your favorite pair of shoes or a 20% discount on drinks at the local watering hole?  Didn’t think so.

You’d try to snatch as many of those shoes or drinks up as you possibly could.  Investing in the stock market should be no different.

You, the young investor, have TIME. You are able to purchase these stocks, funds, etc. at discounted rates and potentially watch them rebound over the long term.

The Simple Solution:  Don’t be afraid of investing because it seems complicated of you’re afraid of losing money.  You have time to deal with market downturns which will inevitably happen.

Think about diving in head first and remember to embrace market downturns as market discount sales.    Start today, no matter how small and watch how potential compounding growth can make your money grow.  Trust me, your future self with thank you.

Mistake #2: Raiding the (Retirement) Coffers

The money you set aside for retirement should be used for only that, retirement.

Too many times I see young investors sacrifice money in the future for current short-term expenses.

On the surface it looks like you may just be sacrificing the money you’re taking out of a retirement account.  Someone may say to themselves, “If I take $10,000 out of my IRA then I’m only taking away $10,000 from my future self.”

Eh, not quite.  You are overlooking the one aspect of the whole transaction which will cost you the most. The 10% penalty the government charges you for taking the money out early and the taxes you’ll have to pay on the money.

Where the Real Sting Is

If you make $80,000 a year you would be in roughly the 25% Federal Tax Bracket and 9.0% State Tax Bracket.

When you take $10,000 out of your retirement funds, you must pay $2,500 in Federal Income Tax and $900 to your State. ($10,000 x 25%) and ($10,000 x 9%)

To add insult to injury, the government punishes you further by applying a 10% penalty for touching your retirement money early (before the age of 59 ½).  That $10,000 becomes $9,000 the instant you withdraw it.

Remember the Early Withdrawal from Retirement Accounts Funnel of Despair Illustration from a previous post titled “Why Your Retirement Funds Should Be Left Alone,” well I have good news… it’s back to help illustrate this point further.

After applying Federal Tax, State Tax and the 10% Early Withdrawal Penalty your $10,000 withdrawal has now turned in $5,600… Ouch.

The Simple Solution:  Stay invested, keep setting aside money for retirement in a systematic way and for God’s sake do not touch your retirement accounts.

Mistake #3:  Not contributing to your company’s 401k plan to get the company match, even though they are essentially giving you free money to participate.*

Just started a new job?  Has the person in charge of HR, Debbie we’ll call her, approached you about participating in the company’s 401k plan?  If so, in the literature and forms she gives you there should be a mention of whether or not the company “matches” your contributions.

Matching contributions essentially equates to your company giving you free money.  All you have to do to obtain this free money is save money within the 401k plan.

Matchy, Matchy

Typically, your company will match what you save up to a specified percentage.  For example, your company will usually say they will match 50% of annual salary up to the 6%.

In normal person terms this just means that your company will give you 3% of your annual salary and put it into your 401k account for you.  The caveat here is that you actually have to save that 3% of your annual salary into the plan in the first place.  No saving by you equals no match (free money) for you.

So if you make $80,000 a year your company will match up to $2,400 annually (3% of $80,000).  Remember, you have to contribute at least $2,400 annually (3% of your salary) to the 401k plan to make this happen.

The Simple Solution:  At a minimum contribute 3% of your salary (as in the example above) or at least contribute enough to get the full match your company’s 401k plan may be offering you.

Take the free money, contribute at least enough to get the full company match and don’t make the mistake I see so often of turning down the free money your company may be offering you.

*Not every company matches 401(k) contributions.  Matching contributions that are offered by companies vary.  Please read the terms of your retirement plan for details regarding potential matching contributions.

Mistake #4: Not Taking advantage of a Roth Account

Roth IRA and Roth 401k contributions can be a young investor’s best friend.  Pay taxes on the money you’re saving now and withdraw the money tax-free when you’re at a much more advanced age.**

Why does this especially benefit a young investor?  Well let me ask you this. Do you plan on being in a higher tax bracket now or when you’re making millions of dollars when you’re older?

I would hope your answer would be that you plan on making more money in the future than you currently are.  Therefore what sounds more appealing?

Paying Less Taxes Now or More Taxes Later

Paying taxes on retirement money NOW when you’re in much lower tax bracket or paying taxes on retirement money LATER when you’re potentially in a much higher tax bracket?

Paying taxes now may be more appealing to you and that’s idea behind using a Roth IRA or Roth 401k contributions for a younger individual.

The Simple Solution:  Consider contributing to a Roth Retirement account.  Pay taxes now while you’re young and don’t pay taxes later when you’re old and potentially filthy rich.

*Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted.

Mistake #5: Trying to be the “Expert” Stock Picker

As much fun as it would be to find the next Google or invest in Nike before “Just Do It” became an international tagline, it’s quite difficult to do.

When you watch the ridiculous, over the top personalities on CNBC or read Marketwatch (cough, Cramer, cough) it is easy to become infatuated with chasing the next hot stock.  Hell, they make it look so easy anyone could do it.

Truth be told it can be done.  It is POSSIBLE to find the next cheap stock that may sky-rocket you to fortunes you’ve only imagined.

Truth be told again, it’s not really probable.  For every Google, Amazon or Nike there are 10 other hot stocks that are no longer in existence.

The Simple Solution: Average investors such as ourselves would likely benefit from putting the majority of our investment funds in a diversified group of funds or exchange-traded funds.

By doing so, you’re leaving the stock picking up to the real professionals (or an index) and concentrating on what’s really important to earning more money from your investments: saving money, advancing your career and having a sound investment strategy that is aligned with your goals in the future.

If you really want to select your own stocks a general rule of thumb is that no more than 5% of your entire investment portfolio should be allocated to your “play money.”  With this 5% you can pick and choose whatever hot stocks you want.

Even if the stocks you select go to zero, losing only 5% of your portfolio would hurt a lot less than if you had chased hot stocks with your entire nest egg.

Mistake #6: Not using this post help to improve the way you invest.

The Simple Solution: Listen to Jake….

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Jacob Dahlstrum and not necessarily those of RJFS or Raymond James.  Diversification does not ensure a profit or guarantee against a loss.  Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment.  Investing involves risk and you may incur a profit or loss regardless of strategy selected.  Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation.  Raymond James financial advisors do not render advice on tax or legal matters.  You should discuss any tax or legal matters with the appropriate professional.

Holding stocks for the long-term does not insure a profitable outcome.  Investing in stocks always involves risk, including the possibility of losing one’s entire investment.

*Not every company matches 401(k) contributions.  Matching contributions that are offered by companies vary.  Please read the terms of your retirement plan for details regarding potential matching contributions.

**Unless certain criteria are met, Roth IRA owners must be 59 1/2 or older and have held the IRA for five years before tax-free withdrawals are permitted.

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