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Smart Money Moves for Young Investors

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At a conference on financial literacy on Apr. 20 in Chicago, Federal Reserve Chairman Ben Bernanke said it was time for Americans to learn to manage their money.

Ramit Sethi couldn’t agree more. The 26-year old personal finance guru has made it his mission to help Americans do just that and he tries to make it as simple as possible.

In his new book, I Will Teach You to Be Rich, and on his blog of the same name, Sethi shows twentysomethings how they can automate their financial decision-making and learn how not to overanalyze.

This is especially true when it comes to investing. He says money should be automatically diverted to investment accounts, then automatically invested and rebalanced, according to a set calendar.

Sethi met with BusinessWeek’s Ben Levisohn on Apr. 17 to discuss how fearful investors can get started in this vexing environment.

You’re only 26. How did you start investing?

When I was in high school, I applied for a number of scholarships because my parents told me we had to. The first scholarship, for $2,000, was written to me and I invested it in the stock market. This was back in 2000. I lost a lot of money. I still have some of those stocks. One is worth 90% in total. I probably lost 99% of that money. That was a great eye-opener. It made me realize that just because you see a stock on TV that does not mean you should invest in it. Just because you’re wearing clothes from Gap doesn’t mean it’s a good investment. That’s when my eyes started to open. But if you ask most people, “hey, what investments do you have,” they say, “you mean stocks?” Which causes me to throw my hands up in the air.

So you’re not a big believer in buying individual stocks. How should people invest?

I want to reduce choice and encourage people to invest. For most, a target date fund is perfect. That’s the 85% solution. It’s not perfect, but it’s good enough. There’s no need for people to rebalance by themselves. The fact that we have 60- to 70-year olds losing 50% of their money speaks volumes that just because you should rebalance your investments, it doesn’t mean you will. Just like you should practice safe sex does not mean you will.

But what if investors want a little more control?

If you really want to tweak it, if you’re a type-A nerd and you’re reading about all different asset allocations, then let me show you how to do this. Here’s a recommendation: the Swensen model, by Yale’s Chief Investment Officer David Swenson. Take this and tweak it as needed. (The Swensen Model allocates 30% to domestic equities, 15% to developed world international equities, 5% to emerging-market equities, 20% to real estate funds, 15% to government bonds, and 15% to TIPs.)

But we need to build systems around automating rebalancing so people are not depending on more will power. Investing and personal finance — we’ve shown that it’s not about more will power. It’s about creating systems that do this by default for us.

So you wouldn’t recommend trying to time the market?

There are people now who pulled their money out. And when the market comes up, they will be some of the last that get in. It drives me crazy. They think this is binary. You either put money in the market or pull it out. That’s not how investing works. There are so many gradations and nuances. You can change asset allocation, you can diversify differently, you can change your time horizon. There are a million things you can do. If you try to time the market, then you are a fool. I’m trying to focus on the long term. I really believe in investing for the long term.

Have you changed your outlook because of the bear market?

I was given the opportunity to completely revamp the book in light of the crisis, but the material stands on its merits. What I tell people is that what’s in the newspaper today and what President Obama decided to do today has very little to do with your personal finances. Personal finances are personal. You can turn off your TV, close down all the Web sites for the next six weeks, and your finances, if you optimize them, would get much better regardless of what happens.

Young investors have watched their parents lose a good chunk of their retirement savings. What do you say to them to coax them into the market when they may feel like socking away their cash in a mattress?

Although it seems catastrophic, we’re in our twenties and thirties and essentially the market is on sale. If I told you one year ago that the market would be 50% off for the same equities you’re buying now, what would you have said? The answer, of course, is I would have been ecstatic. Now there’s a lot of psychology and uncertainty involved and that’s changing things.

How have your investments done in this environment?

I’m roughly indexed, so I was basically in line with the market.

Did you expect these kinds of losses?

I was surprised. The models don’t predict this loss typically. We know there are a lot of problems with models. But as a young person, I’m comfortable knowing I can afford that kind of risk. I was consciously invested and am still consciously invested in a risk seeking way. My readers in their twenties and thirties who are invested are interested in the same. They understand this is a long-term play. They understand there are trade-offs. I’m comfortable knowing that not only do I have a long-term perspective, I’m comfortable managing money, earning more, so it can flow back into my infrastructure.

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Smart Money Moves for Young Investors

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