I began investing in a 401k at my first job out of college back in 1993. I didn't start investing because I knew what I was doing or had a good strategy. I did it because everyone else was doing it and thought it was a good idea. I was sold on the 4% company match because it was free money and that sounded pretty good to a 25-year-old. I couldn't tell you what my investments were back then or what my investing expenses were, I just read through the dozen or so investment descriptions and picked what sounded good at the time. Although this was the first time I invested real money in the stock market, it wasn't the first time I heard about it.
My first exposure to the stock market was in my 10th grade economics class. We played the stock market game where each student was given a hypothetical $1,000 and all the students competed against one another. We were allowed to buy and sell any stock listed in the newspaper. I remember pouring over the daily stock quotes for weeks looking for a good stock. I settled on a "penny" stock that traded between 3/8 (37.5 cents) and 1 3/4 ($1.75). Back then, stocks traded in fractions, sometimes as small as 1/16. Today stocks are traded in dollars and cents, and sometimes fractions of a cent. I did fairly well in the stock market game and my interest in the stock market was born.
In college, I ran across a stock market game called Megabucks which was fun to play, but it was a single player game. Being computer science majors, my roommate and I decided to take it up a notch and wrote Gigabucks, a multi-user stock market simulation. Players on the campus network were able to play and compete against one another for $1 million. We programmed a large number of S&P 500 stocks into the simulation and randomly selected 60 of them for game play. We generated prices around a randomly increasing or decreasing sine wave function. We built a trading process which allowed users to place buy / sell limit orders so they could "buy low & sell high".
My first job out of college lasted six years and I had accumulated a tidy sum of money in my 401k out of sheer luck, definitely not skill. The stock market did pretty well during the 90's dot com run up. One of my co-workers at my first job recommended that I start investing with a company named Vanguard. While he made this recommendation to me in 1997, it wasn't until 2004 that I started moving my investments into Vanguard. If I could go back in time, I would tell my younger self that I should have listened to my co-worker. If I had started with Vanguard in 1999, I might have an additional 15% in my nest egg today because of lower expenses and compounding.
They barely teach personal finance in school. They teach you to open a bank account, how to write checks and play the stock market game in economics class. They cover budgeting in home economics, but until you pay bills for the first time, it doesn't really hit home. They certainly don't teach investment strategy or teach you about expenses associated with investing. While investment expenses have come down over the years due to competition, I still hear stories of people getting fleeced unnecessarily with high fees. In my humble opinion, it is worth spending time learning how the finance industry makes money and know that some investment products are much better than others. You don't need to become an expert and manage your investments on a daily basis. You can simply invest in a target date retirement fund with a low expense ratio. (e.g. 0.08%) Many mutual fund investments carry a 1% expense ratio. While 1% doesn't sound like a lot of money, a 1% expense ratio with an 8% return compounded over 40 years results in 31.71% of your returns lost to needless expenses. In the chart below, the area shaded in red is the amount of returns lost to expenses.
Compound interest is the 8th Wonder Of The World. He who understands it, earns it. He who doesn't, pays it. Albert Einstein
Rules to live by
It's easy to make mistakes with money, and not learning how to deal with money can be hazardous to your wealth. Here are some money management rules I use.
- Pay yourself first - If you invest 10% of your income in low-cost total market index funds for 30-40 years, you should have a comfortable retirement. Some people use the excuse that they don't make enough money to save 10%. If you only make $100 per week, then you invest $10 per week. If you invest $10 per week for 36 years and earn an 8% return, you will accumulate over $100K. As you make more money, you can increase your savings rate.
Do not save what is left after spending, spend what is left after saving.
- Live within your means - While it is fun to have new things, keeping up with the Jones' is not a good strategy for building wealth. If you always spend less money than you earn, you will always have money.
- Stay out of credit card debt - While some debt is necessary (e.g. home mortgage), you want to avoid paying exorbitant credit card interest. Credit card companies make a ton of money off customers even if they pay their card off every month. Let's say you have a credit card bill of $400 every month. The credit card company makes a 4% fee off that $400 from merchants every month. That comes out to $16 per month, or $192 per year, just for lending you $400 every month. That's a 48% annual return on investment for the credit card company! If you pay credit card interest rates on that balance, then you can get to the point where you are paying double or triple for things you buy. Bottom line, save money for big purchases instead of buying them on credit. Don't fall into the credit card trap!
- Live for today and save for tomorrow - Life is not certain and you don't want to spend all your time saving for tomorrow, or watching the stock market, there needs to be a balance.
- Invest in yourself - Invest in knowledge and skills to help you become a better person and make better choices.
An investment in knowledge pays the best interest. Benjamin Franklin