Ramit Sethi, 26, author of the just-released I Will Teach You To Be Rich (and blog of the same name), recently spoke with me about how young people are dealing with the recession. He also argued for why 20 and 30-somethings should continue to put money into the stock market, even if most of their investments so far have shrunk in half. Excerpts:
How do young people think about money?
As young people, we don't pay attention to our money. When there's something you're neglecting and you just hear bad news, you again don't pay attention, but you feel guilty about it. It's a combination of apathy and guilt that comes with money, just like eating and working out. 'I know I should go to gym four days a week, I shouldn't eat that pizza.' We know that we should be figuring out something about money and should probably do a Roth IRA, but we don't know where to get started. There's so much conflicting advice out there.
Will the recession make 20 and 30-somethings more pessimistic and risk averse for the rest of their lives?
Yes. There's a lot of research to suggest that. It's a particularly bad situation for young people because we're already not investing as much as we need to. Going forward, there will be people who say, 'I'm not investing in the stock market,' or 'Crooks can steal my money.' It's hard to convince people, 'No, you have to look long term.' In any 30-year period, the stock market has always gone up.
How can you encourage people to invest when those who were doing so have lost upwards of 50 percent of their money over the last eight months?
There are two separate things: The intellectual and mathematical part, and the emotional part. If I told you nine months ago that you could pick the same investments on a 50 percent sale, it sounds very attractive. But we think of it as a 50 percent loss. Tremendous wealth has been lost, nobody can deny that. But if you're in your 20s or 30s, you don't need money for 30 or 40 years. So on an intellectual and mathematical side, you think, 'I'm going to continue dollar-cost averaging into the market.'
As for the emotional part, I can understand the emotion of saying, 'I've lost so much, I'm going to pull it all out. People often think they have just two levers to pull, put money in or pull money out. But there are other options. You could pull less in, put more in savings, re-allocate investments to put more in fixed income -- there are so many different levers you can pull. If you pull money out, you're guaranteeing you won't be in the market when it returns.
But what if it doesn't return? Japan's stock market has been virtually stagnant for decades.
There are functional and structural differences between us and Japan, but without getting too deeply into that, what strongly effects my belief going forward is what happened in the past. The past doesn't predict the future, but it gives us a fairly accurate view of what's likely to happen. Whether it returns 6 percent or 8 percent -- we can split hairs over that -- the question is, do you fundamentally believe the stock market will go up. If you believe that, then invest. If you don't, where do you put your money? If you only put it in a savings account, it's not going to give you the returns you need to live on. You have to take risks to get potentially high returns.
People like to complain about the economy, but the economy versus your finances are very different. My question is, 'Have you automated your accounts? Do you use a bank account with overdraft fees? Have you set up a conscious spending plan? How much is dedicated to a savings account versus going out and eating?'
I assume you follow your own advice and have money in the stock market, and it must have lost significant value lately. How do you not get down about that?
I built an infrastructure where I only focus on one thing -- earning more. It gets automatically disbursed -- 20 percent to investments, 5 percent to savings, etc. In terms of dealing with losses, first of all, I don't check into my investments every day, and I don't think anyone should. Second, there's a difference between losing when everyone is gaining and losing when everyone has lost.
I'm resolutely focused on the long-term. I do believe the long-term prospects are great, but I'm not a prognosticator. My focus is on living a rich life, which also means being able to visit a friend or buy what you want. Being rich is just partially about money.