Should young investors directly invest in stocks?

May 02, 2022

Many young investors are under the impression that they will learn the ropes of investing if they start investing in stocks directly at a young age.

Investing in actual companies, in contrast with a broadly diversified equity fund, makes an individual aware of what it is to buy a small portion of actual businesses, something that might be lost on buyers of a fund.

What if they go wrong? Well, that is part of the investment process. Moreover, making mistakes when you're investing with small portions of money and you're young enough to recover from them is part of the process and no significant damage is done.

How this young investor got started

Is that really the case?

I approached Morningstar’s director of personal finance for her views. Christine Benz agrees that theoretically all the above are excellent points but brings my attention to Opportunity Cost. She points out that “even small sums, invested well, can add up to serious money over a young investor's time horizon; wasting even a few of those early years with misguided experimentation can have a decent-sized opportunity cost.”

Benz explains that while doing something is indeed often the best way to learn about it, we're not consistently hands-on in other parts of our lives. “If my car started having problems, no one (and I mean it, no one) would suggest that I go out to the garage and try to fix it myself to help cement the value of getting a professional to do it in the first place. Why would we suggest that investors not start with a professional solution first, too?”

John Rekenthaler, vice president of research at Morningstar, adds that the defense to the counterargument that losing money teaches novice investors a valuable lesson, is questionable. “Surely there are better ways to learn that fires burn than to put one's hand into a flame. Besides opportunity cost, the young investor who starts with stocks courts the danger of performing so badly as to become disillusioned, thereby abandoning equities. As Mark Twain said, a cat that jumps on a hot stove will never make that mistake again--but neither will it jump on a cold one.”

When it comes to financial independence, be a hawk, not a chicken.

Here's what to do.

  • Get started with an SIP.

Start by investing small amounts every single month into an equity fund. That will get you started.

If you really want to be a stock picker, start studying businesses. Learn to differentiate between business performance and stock performance. Learn how to read annual reports. Understand what a company moat is. When it comes to small-cap stocks, the management is extremely crucial. You cannot rely on tips from others or from Social Media. If you invest in a bull run, you may end up making money out of sheer luck, but don’t mistake that for skill.

  • Use the advantage of time on your side.

Use the long runway to retirement for your benefit.  Young investors have the longest time to benefit from compounding, and that benefit accrues even if they're only able to save fairly small sums and the market gods serve up pretty average returns.

The 22-year-old who starts saving Rs 1,000 a month and earns a 6% return per year will have over Rs 18 lakh at age 62. If he started 10 years later, he will have less than Rs 10 lakh. Even if we increase the return to 8% per annum, it will be less than Rs 14 lakh.

Those first 10 years of missed compounding swamp both higher returns and higher contributions later on, underscoring the virtue of getting started as soon as you can, even if it means starting small.

So even if you opt for a systematic investment plan, or SIP, of just Rs 1,000 per month, just start. Now. You can increase the amounts every year.

  • Don’t ignore Human Capital

While we're on the topic of "investments" in the broadest sense, the 20s and 30s are also the ideal life stage to make investments in your own human capital--obtaining additional education or training to improve your earnings power over your lifetime. Develop skills. Experiment. Check out various courses or degrees.

  • Don’t ignore debt.

Instead of directly investing in stocks, look at clearing any debt you may have. As Benz says, “it's impossible to earn a high guaranteed return from any portfolio investment today, whereas retiring debt delivers a guaranteed payoff that's equal to your interest rate. Focus on paying down your loans before moving full steam into investing in the market.”

3 Investment Hacks for young people

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