When I attend graduation celebrations, I’m sometimes asked for investment advice. The graduates assume I can help them identify the next Google, or at least help them direct their meager capital into the fund of a latter-day Warren Buffett.
While I’m happy to oblige, I rarely fail to disappoint. My advice contains no hot tips or special insights possessed only by the chairmen of investment management companies. Its sole redeeming virtue is that it has worked. The following straightforward principles can help recent graduates (and, indeed, people of all ages) save and invest their way to financial security.
1. Live Below Your Means
You have to spend less than you earn. This is critical for anyone, but recent graduates are in a better position than the rest of us to make this habit stick. Start on Day 1—when your conception of “the necessities” tends to be more modest than it might be in later years—and you’ll learn to live below your means forever. The longer you wait, the tougher it gets.
The investment benefits are self-evident. If you don’t save, you can’t invest. But living below your means also provides protection from volatility in your personal financial situation. If you suffer financial setbacks—job loss, unexpected health-care costs—you’ll be better positioned to weather those challenges than people who habitually spend every penny they earn.
2. Have a Strategy and Get It on Paper.
This will be your investment portfolio’s business plan, if you will, in which you state your investment goals, keeping in mind that the more specific you are now, the better off you’ll be down the road. “Supporting myself in retirement” is a start, but “generating inflation-adjusted income of $50,000 per year” is much better. You may have several goals, so be sure to specify each.
In this plan, decide how you’ll structure your portfolio to achieve these stated goals. Your primary decision is your portfolio’s asset allocation – the appropriate mix of stocks, bonds, and money market funds. This decision is driven by your investment objectives and tolerance for short-term volatility in the value of your assets.
Finally, think about the ongoing management of your assets. It is a good idea to set a schedule for rebalancing your portfolio to its target allocation and review the funds used to implement your allocation. Periodically check the progress toward your goals to determine whether you’re still on track or need to make modest adjustments to your approach.
3. Participate in The Markets
Until 25 or 35 years ago, it was pretty complicated for Americans to participate in the stock and bond markets. Investing was seen as a pastime primarily for the wealthy. Today, with the advent of IRAs and defined-contribution retirement plans, most people have an opportunity to invest. In fact, investing is the only way for most of us to meet significant expenses such as retirement funding.
That said, your first steps into the markets can be intimidating. Here’s a good example from my recent graduate. My son is pretty financially savvy, but when it was time to enroll in his company’s 401(k) plan, he called me for a second opinion on his choices. I’d have done the same thing at his age.
For many people who are just beginning to invest, a life-cycle fund — a mix of stock and bond funds designed for a particular time horizon — is a great place to start. For others, a traditional balanced fund or a broadly diversified stock or bond fund can get you going, too. But more important than picking the optimal investments is simply getting started.
Once you start investing, you face another challenge: volatility. The financial markets have recently provided a very good illustration of volatility. If you can resist the urge to react to the emotional potholes created by short-term fluctuations in the value of your investments, riding along with (and continuing to invest in) the markets will be a productive experience over many years.
4. Invest Regularly
To emphasize the importance of regular investing, I often tell people about a discussion I participated in a few years ago with some of the Philadelphia area’s best investors, most of whom had enjoyed great business and financial success. The group’s views on financial and investment matters were varied. Discussion and debate were lively. But in the end, I found that everyone agreed on two things: We hate ATM fees (they drive up our costs, so we’ll go out of our way to avoid them), and, more important, a regular saving and investing habit is key to financial success and security.
Regular investing helps you develop the discipline to stick with a long-term investment program through all market environments. It can also reduce the risk (more emotional than financial) of investing a large sum at precisely the wrong time—the 2000 peak of the late-1990s stock market bubble, for example.
Payroll deductions, a feature of most employer-based savings plans, and other automatic investment programs make the mechanics of regular investing simple. I consider newer innovations, such as Vanguard’s One StepTM, which allows 401(k) plan participants to automatically increase their savings rates as their salaries increase, a corollary to compound interest. Together, these forces are a powerful engine for wealth creation.
5. Get Knowledgeable About Financial Markets and Businesses
Become a regular reader of The Wall Street Journal, the business section of your local paper, and the educational material provided by many investment companies. The goal is not to become a professional investor. In fact, if you wind up reacting to what you read in the press or hear on television, you may do yourself more harm than good. Instead, your goal should be to become familiar with the way the markets behave. Over time, this familiarity will help you establish — and stick with — a well-constructed, long-term investment plan.
Simple Principles That Will Stand The Test of Time
Is this advice boring? Maybe. It’s certainly not “plastics,” the pithy career advice immortalized in “The Graduate.” But unlike “plastics,” my advice for recent graduates is timeless and solid. Indeed, I offer more or less the same advice to 32-, 42-, and 52-year-olds—five simple principles that have helped guide hundreds of thousands of Vanguard shareholders to long-term financial security.