Invaluable investing advice for young people

April is financial literacy month, at least according to the Jump$tart Coalition for Personal Financial Literacy. Jump$tart is a group of diverse financial education stakeholders that work together to educate and prepare American youth for life-long financial success.

In her book Pound Foolish (Penguin 2012), Helaine Olen looks at the coalition's 150 sponsors, pointing to such household names as Bank of America (BAC), Visa (V), Wells Fargo (WFC) and Morgan Stanley (MS), and questions their motives. Indeed, the coalition's website includes the stock market game, a simulation of investing where, over several weeks, winners get rich quickly and losers face no consequences. I know because my 16-year old son has been forced to play this game of gambling twice in school.

For those who are concerned that such personal finance education is oriented toward the status quo, author and financial theorist William Bernstein has just written a simple, short ebook titled "If You Can: How Millennials Can Get Rich Slowly." To achieve the title's goal, he says you have to overcome five simple (but not easy) hurdles.

Hurdle one: Don't spend all the money you make. You've got to live below your means and save. Bernstein notes that even if you can invest like Warren Buffett, you'll die broke if you don't save. Putting away at least 15% of your salary is critical. Millionaires become and stay millionaires because they're typically frugal. Building wealth requires delaying the immediate gratification that siphons wealth away.

In many ways, financial frugality is similar to dieting. It's hard saying no to that doughnut or cheeseburger, but doing so leads to better health later in life. We want to believe there's a magic weight-loss pill just like we want to believe we can buy everything today and still get rich quickly.

Hurdle two: Understand basic finance. Learn about the difference between a stock and a bond as well as the difference between luck and skill. Bernstein points to Bill Miller whose Legg Mason Value Trust fund bested the S&P 500 for 15 consecutive years. Ultimately, Miller ended up losing more money than he ever made for investors. Those who believed it was skill, misunderstood the mathematics of tens of thousands of managers with a near certainty that one or two would have such a track record.

Finally, understand that higher expenses lead to lower returns.

Hurdle three: Don't ignore financial history. Typically, we think a strong economy leads to great investing returns and vice versa. History shows the opposite. Have the discipline to maintain a fixed allocation of stocks and bonds. That way, you'll be selling stocks after they surge and buying after they plunge, which is the exact opposite of what most investors will be doing.

Hurdle four: We are the enemy. When it comes to investing, our brain exhibits pathological behavior. We seek out patterns to predict the future, yet what we're really doing is just predicting the recent past and chasing past performance. Neither good times nor bad last forever.

Hurdle five: The financial services industry wants to make you poor and stupid. Bernstein says if you've read about the previous four hurdles, you'll know more than the typical stockbroker or financial advisor. Bernstein warns "you are engaged in a life-and-death struggle with the financial services industry." Keep fees low.

He says to put equal amounts of your savings into three low-cost funds:

  • A U.S. stock market index fund
  • An international total stock market index fund
  • A U.S. total bond market index fund

At what age should you start teaching children about money? I began teaching my son when he was eight, right after he first had to play the stock market game. His second-grader portfolio has different proportions of the same three funds. Though he didn't win the stock market game, his portfolio has gained 16.02% annually over the past five years as of April 14, 2014, and his portfolio is one of the eight Lazy Portfolios tracked by Dow Jones' MarketWatch. That's real money, not a get-rich-quick game.

Author's note: Bernstein's ebook is 99 cents on Amazon but will be free on April 25.

  • Allan Roth On Twitter»

    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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