Twenty-first century college students face challenges that make investing difficult. Tuition has generally risen faster than the cost of living. Textbooks are are becoming even more expensive. A good job following graduation may not be immediately available. Despite these obstacles, beginning an investment program as an undergraduate is a good idea. Two phenomena suggest why: the long-term history of the stock market and the time value of money.
Long-Term History of the Stock Market
The S&P; 500 Index, based on the cumulative value of 500 broadly diversified large U.S. corporations, is often used as a gauge of the overall stock market. Since 1950, the index has gained 11 percent annually. Over shorter terms of five and even 10 years the market is more volatile. In each of the past seven decades, the market has lost money in only one decade and returned more than 15 percent in three, while coming within 4 percent of the 11 percent market average only once. However, over successive 30-year periods since 1950 -- 1950-1980, 1960-1990 and so on -- the market returned within one percentage point of the long-term average three times and never returned less than 9.4 percent or more than 13.7 percent. When you invest over a long time, you have a higher probability of succeeding.
The Time Value of Money
Consider two hypothetical investment scenarios. In the first, you invest no money while enrolled in college. Once you have a full-time job following graduation, begin investing more. If you are able to invest $500 each month in an S&P; 500 index fund, because the index's average annual return on investment since 1950 is 11 percent, your investment could grow to $2,755,660 in 36 years. In the second scenario, you invest $25 per month during your four years in college in the same index fund, then following graduation invest $500 monthly for the next 36 years. By then, your investment will have grown to $2,834,827. By investing $25 per month as an undergraduate, you could have nearly $80,000 more for your retirement years. Money invested early pays huge benefits over time.
Hazards of Investing
Some younger investors may be tempted to "beat the market," not fully realizing that potentially higher returns are intrinsically related to higher risks. In fact, only a small number of mutual fund managers are able to achieve better-than-average returns for two years in a row. On the other hand, as Jeff Reeves notes in a revealing Huffington Post article, other younger investors, cautioned by their parents, tend to invest in very low-return, low-risk funds more suited for retirees. Neither course is likely to yield the returns you hope to retire on.
A number of academic studies are in broad agreement. The best returns over the long run are achieved by highly diversified stock funds with low management fees that emphasize value over growth. Value funds are actively managed mutual funds or index funds that invest in undervalued equities with low price to earnings ratios. Growth funds are funds that have a recent history of high performance and may have high price to earnings ratios. Another tip: Studies also conclude that investors who keep their money invested in the market do significantly better than those who try to time the market.
- Bankrate: Simple Savings Calculator
- NYU Stern School of Business: A Primer on the Time Value of Money
- U.S. Securities and Exchange Commission: Financial Navigating in the Current Economy -- Ten Things to Consider Before You Make Investing Decisions
- Fidelity: Growth vs. Value Investing
- InvestingDaily: The Growth vs. Value Debate -- Depends on the Holding Period
- Huffington Post: Time Is on the Side of the Young Investor -- Taking Risks Can Pay Off
- Simple Stock Investing: S&P 500 -- Total and Inflation-Adjusted Historical Returns
- The Wall Street Journal: With Fund Managers, Past Is No Predictor for Future
- NYU Stern School of Business: Investor Sentiment and the Cross-Section of Stock Returns
- Comstock Images/Stockbyte/Getty Images