Friday, May 4, 2007

Investment Ideas for the Young

So at work today, we had an interesting ad-hoc discussion about 401(k)s and long-term investing. A strategy that one of my finance professors had talked to me about surfaced from one of my coworkers. He (and my professor) suggested that for young investors looking to invest long-term, the best way is to put 100% into something that you really believe in and ride it out.

The idea is that for most large companies and volatile companies, the general trend is upward, but day to day you can expect huge swings, that does not match any stock index.

Take for instance the S&P 500 historical returns. Looking at the returns, here are the breakdowns by length of investment and simple annual return on investment (ROI):

1 Month: 4.33%, 51.96% ROI
3 Month: 3.07%, 12.28% ROI
6 Month: 7.58%, 15.16% ROI
1 Year: 13.11%, 13.11% ROI
5 Years: 37.65%, 3.77% ROI
10 Years: 84.99%, 8.50% ROI

As the investment length increases, the APY levels out to about 6.3%, which implies decreased riskiness but this level of return is also very low.

Now consider a big company like Exxon (XOM), which is constantly in the public eye, and hence has huge short-term volatility (adjusted for dividends) with ROI:

1 Month: 4.31%, 51.72% ROI
3 Month: 10.45%, 41.80% ROI
6 Month: 12.61%, 25.22% ROI
1 Year: 28.18%, 28.18% ROI
5 Years: 122.39%, 24.48% ROI
10 Years: 246.30%, 24.63% ROI

While the APYs are a bit misleading in the past 3 months due to earnings reports, you can see that the overall 10 year returns with simplified ROI show that the one investment is better than the stock index, effectively representing diversification.

This is something to consider for younger folks, but those that don't have AT LEAST 10 years to invest should definitely not try this.

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