The Importance of Financial Education

To embark on any journey successfully usually requires a well thought out plan. If the destination is a comfortable financial future, we should have a good understanding of the best paths to take. This is why financial education for the younger generation is so important: to help them navigate as effectively as possible towards whatever their future holds by having a proper understanding of the impact of financial decisions.

Given the importance of a solid financial education, we hold a Young Investor day each year for young adult children of our clients. The day is designed for the participants to come away with a better appreciation for what investing means, along with some of the most important things to get right and how this will help them achieve their goals in the years to come. Perhaps the most rewarding aspect of these sessions is the universal feedback we receive: "I never thought investing could be this interesting!"

Below are some of the areas that can make a significant difference to long-term financial wellbeing:

Start investing as early as possible

There are good reasons why investing early is so important – the arithmetic is impossible to ignore. By starting earlier in life, and therefore being invested for longer, the power of compounding helps to magnify returns.

For example, assuming returns of 6% a year, the power of compounding means that while £100,000 could grow past £200,000 over 12 years; it could exceed £1 million over 40 years.

This chart shows how much less you need to put aside earlier in life to achieve a £1 million goal.

Compounding can double your money in 12 years
and multiply it over 10 times in 40 years

Source: Netwealth. Illustrative, assuming an annual return of 6% compounded each year.

The significance of diversification

Being diversified – to spread risk – is another factor where it’s hard to argue with the facts. Different asset classes (such as shares, bonds and cash) tend to perform differently over time. For example, shares might be king one year, while stock market weakness may mean bonds outperform the following year.

But being properly diversified is not totally straightforward – the type of asset (eg, UK shares or US corporate bonds) must be considered and also the regional location of assets (eg, Europe or China). Given the available choices, the permutations of regions and types of asset that need to be monitored quickly grows. For many it is preferable to use someone else’s effort and time to maintain appropriate diversification under differing scenarios. That raises the question of cost.

The impact of fees

The fees to manage money – to invest and oversee it on your behalf – are usually in the low single digits (1 to 3%), and a slight variance in these may seem of little consequence. However, over time, the impact of just a 1% saving in fees can make a dramatic difference to an investment pot. As this article examines in detail, a £500,000 investment portfolio could be worth £80,000 less over 10 years and £240,000 less over 20 years (assuming the same rate of returns) when working with a traditional wealth manager charging 1% more in fees than Netwealth.

Control the factors you can control

There are many factors you can’t control when investing, such as inflation and market performance, but you can make a meaningful difference by attending to the factors that you can influence. We explore some of these ‘controllables’ here – which include the benefits of low fees and diversification – and examine the impact they could have as you invest over the long term.

Equally, while we may not have autonomy over how long we live, we can reasonably expect to live longer than previous generations (a 30-year-old woman today now has a life expectancy of 90). Many aspects of longevity align with important lessons for younger investors, and we encourage readers to take a look at this article, which contemplates the different choices we may have to make to pay for living longer.

Don't delay investing

Starting to invest early is best, but even if you’re late to the party, don’t delay further. All of the factors above matter for an investor, no matter what age.

It is never too late to take control and try to position ourselves for the best possible financial future.

Please remember that when investing your capital is at risk.

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