At the end of the last decade, young professionals watched in horror as the stock market lost more than half its value over a year and a half span. College savings accounts were decimated, plans for retirement postponed, and, in direr situations, homes and cars were lost.
Many young people who witnessed this turmoil during their formative years walked away with what they thought was the lesson to be learned from the market’s tumble: don’t invest in the capital markets.
Sadly, without a foothold in the market, many of today’s young professionals are putting themselves in a precarious financial situation.
“If your money is solely in cash or cash equivalents,” said virtual advisor Andrew McFadden, founder of Panoramic Financial Advice in Fresno, CA, “chances are you won’t even keep up with inflation.”
Plus, he added, younger investors have a distinct advantage over their parents. The more time your money has to compound, the more powerful your investment potential. (The difference between starting early and waiting until later can add up to as much as $1 million).
83 million millennials felt the repercussions of the stock market crash last decade. If you’re among that cohort and are afraid to start investing, read on to learn how to overcome your fear.
1. Get educated
Instead of shying away from investing, McFadden suggests that young investors work toward learning how the markets work so they can prepare themselves for future market conditions.
Katie Brewer, CFP®, Financial Coach for Gen X and Gen Y with Your Richest Life, said financial education should not come from the news media, which tends to sensationalize short-term market events.
“They’re all about the market crashing, or the hottest new stock. That’s not an education source,” she said.
Instead, she suggests beginning investors peruse their local library or bookstore for the financial planning classics. Her favorite is “The Investment Answer,” by Daniel C. Goldie and Gordon S. Murray, which is a short, 87-page read. McFadden likes The Dummies Guides. “They break things down very simply,” he said.
McFadden is convinced a lot of the fallout from last decade’s bear market was because investors hadn’t properly educated themselves.
“Most of the people who were that close to retirement shouldn’t have been invested in such an aggressive portfolio at that time in life,” he said. “Plus, market losses aren’t realized until you sell.”
McFadden is on to something. It took several years for the market to recover to its pre-bear level, but as those who stayed the course saw, the S&P 500 was back on track by 2012 and continues to trend upward, albeit with a few bumps in the road (which long-term investors know to accept as par for the course).
2. Play the long game
Brewer agrees with taking a long-term approach toward investing. Before getting started, she suggests potential investors take a look at the historical context. “Look at the 10-, 20-, and 30-year returns,” she said. “One-year returns are completely irrelevant.”
Staying out of the market is not a strategy that will benefit most millennials over the long term, she said.
“The stock market is more volatile than it used to be. Mostly because of technological advances that make it easier to conduct large trades. Even so, if you look at the returns over time, and you’re not planning to retire in the near future, most people will still benefit over the long run.”
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3. Start small
“Instead of throwing all your money in at once, start with an amount that you’re comfortable with,” said McFadden. “You can start many accounts for less than $1,000, which won’t make or break you, but can give you the experience to be a more confident investor.”
As the ancient Chinese philosopher, Lao Tzu once said, “The journey of a thousand miles begins with a single step.”
For those whose employer offers a 401(k) or other defined contribution plan, Brewer suggests investors start there. “A 401(k) plan is a boring, great place to be,” she said.
4. Understand your strategy
If you’re nervous about the market, it’s important to understand how to set up a conservative investment strategy. “I see a lot of younger people who are afraid of the risk inherent to the market,” said Brewer, “but then they sign up for a bunch of their company stock and an aggressive portfolio because someone told them they should.”
McFadden agrees. “Many advise younger investors to be aggressive with their investments,” he said. “But risk capacity – which is based on timeframe – is only one half of the equation. Tolerance for risk is the other.”
In other words, it’s important to know you’d react if the market swung 50% up (or down). If you’re averse to the downswings, it doesn’t make sense to have a large amount allocated to stocks, no matter your age.
When developing an asset allocation strategy, Brewer suggests the following rule of thumb as a foundation for figuring out an equity (stock) allotment: 110 minus your age. If you’re 25 years old, Brewer would suggest investing 85% (110 – 25 = 85) of your portfolio in stocks and the remaining 15% in less risky assets like bonds or cash.
“Diversification is key,” said McFadden. “Young people should consider mutual funds because it’s an inexpensive way to get exposure to the broader market.” He also suggests bonds or bond funds as a tool to learn about investing, without taking on too much risk. More secure bonds, like US Treasuries, have a very low risk of default. Higher-risk junk bonds (corporate bonds issued by lower-rated companies), meanwhile, carry more risk, but also have the potential to enhance investment return.
As investors become more seasoned, McFadden suggests adding exposure to real estate and commodities. “I wouldn’t suggest more than a 5% position to either,” he said, “but each can be a good portfolio diversifier.”
5. Be consistent
To follow the most well-known investment tenet ever uttered – buy low and sell high -one must develop a plan to set aside one’s emotional biases. It’s fear that prompts investors to sell low at the market bottom and greed that encourages them to buy high at the market peak.
By adopting a strategy of systematic investing at predefined intervals over a long time horizon – an approach known as dollar-cost averaging – the costs of investing in the market “even out over time,” said Brewer.
With a consistent plan in place, it’s easier to take emotion – and potential human error -out of the investment equation.
Fear of investing in the stock market makes sense in the short term. After all, we’ve all just witnessed one of the biggest crashes in history.
When you start looking to the future, though, drops in the market are overshadowed by overall, long-term growth. If your fear of the market keeps you from investing, you may be giving up hundreds of thousands of dollars. So get started in small ways, stay diversified to minimize risk, and play the long game.
You can’t afford not to.
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