3 Critical Details Millennial Investors Neglect

Beginner investors often face a unique set of challenges when setting up their investment portfolio. Whether they are aided by an experienced financial advisor, or creating and managing their portfolio themselves, there are some prudent financial concepts and objectives that should be accounted for to ensure a strong foundation and a stable growth system moving forward.

Here are some tips for millennial investors as they find their feet in the world of investing:

1. Planning for Retirement

As counterintuitive as it may seem, planning for retirement is one of the first objectives that beginner investors must achieve.

A good reason to start saving early is that usually the younger you are, the less likely you are to have burdensome financial obligations: a spouse, children and mortgage, for example. That means you can allocate a small portion of your investment portfolio to higher risk investments, which may return higher yields.

When you start investing while young, before your financial commitments start piling up, you'll probably also have more cash available for investing and a longer time horizon before retirement. With more money to invest for many years to come, you'll have a bigger retirement nest egg.

To illustrate the advantage of value investing as soon as possible, assume you invest $200 every month starting at age 25. If you earn a 7% annual return on that money, when you're 65 your retirement nest egg will be approximately $525,000.

However, if you start saving that $200 monthly at age 35 and get the same 7% return, you'll only have about $244,000 at age 65. 

2. Diversification

Diversification  is a risk management technique that mixes a wide variety of investments within a portfolio.

The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. The medium and low risk asset compensates the high risk one and the aggregate returns are generally higher than a single asset portfolio. The wise decision to make is to reinvest your returns to earn greater returns, rather than spend those returns. For an investor, this is the best way to prevent a massive setback.

Numerous studies have determined that asset allocation is the most important aspect affecting performance and volatility of your investment. In fact, 91% of the portfolio return is based on asset allocation, just 2% on market timing, 5% on stock selection and 2% on other factors.

3. Benefits of Dividend Stocks

Younger investors often gravitate towards "next big thing" stocks and disregard the slower growing, dividend paying stalwarts. But buying those dividend payers, and reinvesting the distributions, is a great way to ensure long term success.

One of the best ways to build wealth is to look for companies that are not only prospering but are also sharing the wealth with its shareholders by paying a regular dividend.

Younger investors often overlook dividend stocks because they are perceived as boring; exciting companies or “hot” IPO stocks often do not pay dividends.

But dividends are crucial to building wealth.

Example: Let's say we own 100 shares each of two companies. Both are valued at $20.00 per share. One pays a quarterly dividend with an annualized yield of 3% while the other pays no dividend.

If both of our stocks grow at an average annual return of 6% for 30 years, the

company without a dividend will be worth $11,486.98 at the end of that period.

That might seem acceptable until you see how much you made in the other company after reinvesting the 3% dividend every year.

The value of the dividend-paying company after 30 years would be $83,353.98.

You see, when you reinvest the dividends you buy more shares. So every quarter you are increasing the number of shares you own and also the amount of income you are receiving, which means you are buying more and more shares every quarter. This is a vivid demonstration of the benefit of compounding.

While there are numerous principles and concepts to understand before creating an investment portfolio, it is crucial to have a tight grip on the foundations of responsible investing, as well as a detailed understanding of your current financial situation. To aid you on your path to financial freedom, here is some information on Four Financial Ratios (linkback to Four Financial Ratios for Investment Beginners) that you should get familiar with as well.