Editors Note:
Burt Mayer, a senior at Lakeside High School in Seattle, WA interned at Merriman this summer with the intention of creating educational material for young investors.  This three part series featured on FundAdvice.com is perfect for those investors who are looking to get started but need to know the basics first.

As young adults, we already invest ourselves in many things. We invest our money in consumer electronics and clothing. We invest our emotions in the success of our sports teams, our time in the strength of our friendships, and sometimes our energy into our schoolwork.  Yet we persistently fail to invest in our financial futures.

Financial Responsibility through the Lens of Hip Hop

We as a generation are utterly financially illiterate. In the spring of 2008 the U.S. Treasury Department’s National Financial Literacy Challenge test was given to 46,000 high school students across the country. They returned an average score of 56%. The Jump$tart Coalition for Personal Financial Literacy conducted a similar survey this year of 6,800 high school seniors in 40 states and returned an average score of 48.3% As a current high school student myself I can fairly confidently say that both scores would most often be marked as ‘F’s. Where could this sweeping financial ignorance possibly have been bred?  I turned to our generation’s greatest poets to shed some light on this question.

The rapper “50 Cent” eloquently expresses the value that America’s youth place on income in his tour-de-force hit “I Get Money”:

I get money, money I got (I I get it)
I get money, money I got (I I get it)
I get money, money I got (Yeah)
Money I got, money I got

Sure enough, young adults today do generate more income than people our age have in the past. Yet it seems we’ve developed unfavorable habits in how we dispose of it. Lil’ Wayne provides an excellent example in his profound “Got Money”:

Got money
And you know it
Take it out your pocket and show it (then)
Throw it
This a way
Thata way
This a way
Thata way

Rather than throwing his money “this a way” and “thata way,” Lil’ Wayne likely would’ve done better investing it in his 401(k) or savings account. Or a thesaurus.

Lil’ Scrappy similarly touches on poor financial habits:

My Chevy clean and the paint look like lemon-lime
You wanna shine, it ain’t hard, just get on your grind
We keep a bankroll, wallet full of credit cards
Cup full of Cristal, box full of cigars

While I commend Scrappy on his automotive hygiene, I would warn him against a “wallet full of credit cards” as they can quickly rack up significant amounts of high-interest debt. According to school loan provider Sallie Mae more than half of all incoming college freshman have credit cards which, on average, carry $1,585 in debt.

So where are all the rappers preaching good saving habits and financial responsibility? Meet Terence Bradford, a stock-broker turned underground rapper from the Bronx, New York.

You a gangsta? Then go get your paper.
I’m a paper gangsta getting stock quotes on my pager.
Thousands on a whip [car] don’t make you a star.
I’m buying options on the companies that makin’ them cars.
Come on! Get stocks and bonds!

What Bradford understands, in addition to the intricacies of flow and rhyme, is that today’s teens and young adults generate substantial income but fail to utilize their capital in ways that might be beneficial in the future.

According to globally recognized teen research firm TRU, Americans aged 12-19 spent $176 billion in 2007 alone. Despite the tremendous teenage income this statistic implies, only ⅓ of teens saved more than 10% of their intake and 41% didn’t save anything at all. Most of these teens are financially dependent on their parents, their income likely taking the form of allowance or compensation for household chores. Without the concerns of tuition, debt, and rent they were free to spend predominantly on clothing, going out to eat, entertainment, and electronics. Once they enter the 21-29 year-old demographic they become increasingly financially autonomous, yet haven’t developed the skills necessary to handle their personal finances.  Over 35% of twenty-somethings have student loans which average $17,000, but only 16% of these young adults saved more than 10% of their income last year.

At least we’re aware that we’re doing a poor job. A 2007 survey conducted by Wachovia Bank reveals that of all age groups, young adults 18-24 are most likely to say that they’re not saving adequately (62% versus 52% for all Americans). Additionally, a market research report published in 2003 by Datamoniter concluded that 72.1% of European young adults are concerned that they will not have enough money to retire but fewer than half actually do any saving. The problem is global. It is my inexpert and completely unqualified opinion that without dramatic reform, young adults everywhere are headed for dramatic and unprecedented financial crisis.

The Math

I’ve taken it upon myself, a 17 year-old boy with a B+ in math and a $100+ collection of Axe Deodorant Body Spray, to save our generation from poor financial decisions and educate on the benefits of investing. I’ll present how I was initially convinced to set aside some of my hard-earned allowance money and put it towards my future:

Brokers, analysts, and fund managers on Wall Street spend millions of dollars every year researching how to maximize their profit from the stock market. They hire brilliant mathematicians and Nobel Laureates to tweak their strategies. But we all have something that none of them do; the only key to almost certainly making significant money: We have the benefit of time.

The amount that a lump sum will grow in the market can be modeled by a relatively simple function:

A = P × (1 + R)N
where A = money after a given time, P = principle investment, R = annualized rate of return, and N = number of years invested

How much money we make in the market is defined by 3 variables: the amount we initially put in, the rate of growth our money is experiencing, and how long we leave it alone. We have little control over how the market behaves so for the time being we’ll ignore the rate of return and focus on principal and time. While our money has a linear relationship with principal (doubling the principal doubles the ultimate return), it increases exponentially with the number of years we’ve invested. The money grows faster and faster as time goes on because the interest we’ve made begins to earn interest of its own. In a nutshell: the earlier you start investing, the more money you’re going to make.

The graph above presents the stories of three investors who each decide to put away $1,000 every year in the same portfolio that yields 8.5% annualized return until they retire at age 65. They’ve done almost everything the same and yet one of the investors now has 6 times the money of one of the others! The only difference between these three investors is that they got in the game at different points in their lives. The first investor has made $186,043 more than the second simply because he started investing 10 years earlier. If he had invested only 5 years earlier, at age 20, he would’ve made an additional $168,010 bringing his total at age 65 to $489,826. The actual American stock market has historically returned better than 8.5% — if our first investor had started investing 45 years ago in the S&P 500, which has returned an annualized 10.3% over that time span, he would now have a whopping $872,632. He only put in $45,000 over the course of his life but now he’s driving a different supercar every day of the week, simply because he started investing small amounts while he was in college.

The “Rule of 72” is an easy way of calculating how long it will take for money in the market to double in value, given a certain rate of return. Dividing the number 72 by the annualized rate of growth gives the number of years until the money experiencing that growth doubles. For instance, a portfolio making 9% annualized return will double every 8 years. The following graph provides an illustrated example of the doubling power of money given a 9% yield.

I recognize that 16 years is a fairly lengthy amount of time to wait for an extra 30 dollars, but rest assured that given an additional 118 years this sum will grow to a cool $1,000,000.

Recommendations for Saving and Budgeting

A paycheck can feel like it’s burning a hole in your pocket (I’m guessing), but before you go out and blow your money on things you could have downloaded illegally you should consider setting the money aside for your savings.

Here are a few tips to get you started on saving your money:

  • Pay yourself first: Set aside 10% of your income at the very minimum for investing (hopefully closer to 20%) before you do anything else.  The more you set aside now, the happier you’ll be later on.
  • Collect your spare change in a jar, it’ll get heavy fast.
  • Don’t impulse shop!
  • Wait before any major purchase to make sure that it’s something that you really want or need. “Sleep on it” and return to the decision with a clear head.
  • Consider the “opportunity cost” of any item. What would I be able to buy with this money later on if it grows every year? Is an Xbox now worth a car when I’m older?
  • Saving is always about self-discipline. Learn to delay gratification and set aside your monthly savings methodically and automatically. Don’t just save when you find yourself with extra money; make the commitment to saving a certain percentage of your income every month.

I’d bet any investor will tell you that they wish they had begun saving earlier. They understand that starting to put away just a little money during high school or college can mean the difference between Batman Spaghettios and filet mignon in retirement.

Saving and investing aren’t tremendously difficult but they’re something you need to be proactive about doing. Just like hip-hop, you don’t have to be very good at it to make a lot of money. But without establishing positive financial habits now, you might end up throwing your money this a way and thata way and never get a chance to sip Cristal.