The party in the financial markets is long over. Talks of hot stocks and fabulous opportunities in cryptocurrencies and NFTs have dwindled to a whisper. Recession and bear market are the big buzzwords these days.
Clearly, this is not the happiest time for investors. If you’ve never put money on the market before, this might not seem like the most obvious time to start.
However, there are advantages to investing in a bear market. With stocks falling in value and day traders giving up, you are less likely to be swept up in fads because almost none of them are profitable. Instead, you can focus on the essential goal of increasing your long-term wealth.
Most of my columns are geared towards people who already have some involvement with stock and bond investing, usually using mutual funds or exchange-traded funds. But this column is a little different. It was written primarily for people who are still in school, or just starting out in the workforce, or just starting to save money for the future.
It’s for people like Lucy Neal, who graduated this month from North Central High School in Indianapolis and said in a note: “I feel like I have no idea what to do to ensure my own financial security (even though I’ve just completed my degree). AP Macroeconomics class!).”
In a phone conversation, Neal said it would be helpful to have basic, reliable information on how to start investing and maintaining it. So here’s a quick summary. It can be useful even if you’re a veteran at this, but it’s primarily aimed at beginners. If you have any other specific questions, please write and I will try to answer them.
The market decline this year shows how easy it is to lose money, even if you’re careful.
However, investing can be rewarding if you start early, focus on the long term and follow a few simple steps, which I will explain.
Pay your bills first and save for emergencies, before putting any money at risk.
Buy stocks – and when it suits you, bonds – using cheap, diversified index funds that track the entire market.
Think of investing as a marathon, not a sprint, with a minimum horizon of 10 years, and preferably with a much, much longer goal in mind.
First, pay your bills and set aside some savings
Investing involves taking risks. You can minimize these risks, but there’s no way to get around them entirely, especially when you put money in the stock market.
So, before taking any additional risks, make sure you can pay your bills. After that, try to save enough money for an emergency.
Spend a little less, save a little more, and do it regularly. Soon you will have a good nest egg. Keep this in a safe place.
The stock market situation
The stock market decline this year was painful. And it remains difficult to predict what is in store for the future.
For short-term savings, a bank account or money market fund makes sense because your money will be safe and you can get it quickly. You can find money market funds at large companies like Vanguard, Fidelity, T. Rowe Price or Schwab. The interest rate is low, but it is rising.
For safe long-term savings, try I bonds, which are issued by the Treasury Department and pay 9.62% interest (rates are adjusted every six months), bank certificates of deposit, and high-yield savings accounts.
Buy stocks, not cryptocurrencies
You are now ready to invest.
I put my own investment dollars only in widely diversified funds that hold both stocks and bonds, and this is what I recommend for anyone starting out. Stocks and bonds are the two main asset classes, and you don’t need anything else. Funds – specifically, index funds that track the market – are a great, inexpensive way to buy stocks and bonds. (What do I mean by cheap? You will generally pay much lower fees than in what is known as an actively managed fund.)
Before proceeding, consider the following: as an investor, I would not put any money directly in cryptocurrency, NFTs, gold or wheat, other commodities or anything else. You don’t need them in an investment portfolio and you are taking extra risk if you buy them.
What’s more, if you invest in the entire stock market through index funds, you will be exposed to these things anyway, because you will have shares in the companies that hire, trade, or service them. These include Coinbase, a platform that enables cryptocurrency trading, and PayPal, which owns Venmo and encourages customers to buy cryptocurrencies. If these or other companies can make money from cryptocurrencies, great; you will too. If they don’t, the losses will be offset by other equity investments.
This is what diversification means. Buy the entire market and you will minimize the effect, for better or worse, of any small part of it.
Now for stocks and bonds: if I had the great luxury of youth, with decades ahead of me to recoup potential losses, I would focus on stocks. In fact, despite the pain of the bear market, understanding what I know now, I would invest 100% in stocks if I was in my teens or 20s.
I don’t have that luxury, though. I’m closer to retirement than my first job, so I own a fair amount of bonds, which are generally more stable than stocks and let me sleep at night. But bonds are not what I would buy if I were 18, as Neal is, because stocks return almost twice as much as bonds over the long term: 12.3% annualized for stocks versus 6.3% for bonds, according to calculations by Vanguard of market returns from 1926 to 2021.
And the losses?
The bear market is on Neal’s radar. “I keep seeing that the stock market is at a record low,” she said in a phone conversation on Tuesday. “But does that mean it’s a good time to buy stocks?”
My answer was equivocal.
Yes, it’s a great time to buy stocks if you’re really interested in the long term. Prices are much better for buyers than they were at the beginning of the year because we are in a bear market, which simply means that the stock market in general is down at least 20% from its peak. While the past does not guarantee anything about the future, the fact is that the US stock market has always recovered from declines over periods of at least 20 years. If you can plan to buy and hold stocks for 20 years or more, buy now.
But no, it might not be a good time if you’re trying to make money quickly. The trend in the stock market so far this year has been negative. You can lose money right away. Then again, the market may start to rally tomorrow and maintain the uptrend for a long time. I don’t think this is about to happen, but no one really knows.
In short, understand the risks you are taking. Don’t buy stocks unless you are prepared to withstand short-term “paper losses” and can keep your money in the market for a long time. And consider why you are buying stocks in the first place.
stock index funds
Why is investing in stocks such an effective way to make long-term money?
The answer may not be obvious. A lot of “meme stocks” like GameStop and AMC have gone up sharply in the last year, not because they were solid investments, but mainly because a lot of people wanted them to go up and keep buying. Over months and sometimes even years, this kind of herd behavior — what economist Robert J. Shiller calls “irrational exuberance” — can inflate prices and generate a sizable profit.
But if you rely on the emotions of strangers to set the prices for you, you could also lose a lot of money when the market goes down, as has been the case lately.
Mrs. Neal, an economics student, came up with what I think is a good answer: Stocks provide long-term returns to shareholders because the economy grows in the long run, and companies in the stock market together profit. These growing profits accrue to shareholders. And that’s what you essentially are as a stock investor – a shareholder – even if you only own a small slice of a company through an index fund.
Over very long periods, this growth was extraordinary. The stock market’s 12.3% annualized return means that, on average, your money would have doubled in less than six years, repeatedly, over many decades.
Note that we are not talking about choosing specific actions. Which companies will prosper and which will fail? Which stocks will perform better this year or next? It’s hard to know.
Likewise, no one knows where the stock market is going day by day or year by year. In December, the vast majority of Wall Street analysts said the stock market would go up in 2022. Oops. They got it wrong.
None of this is critical if you invest the entire market for the long term, putting money in regardless of short-term market movements. This approach is incredibly simple. You can use just one index fund to capture the entire US stock market or even the entire world stock market. Look for an index fund with low fees by comparing what is called an expense ratio. Shop around, do your research.
Keep your investment as simple and inexpensive as possible. As John C. Bogle, founder of Vanguard and creator of the first commercially available index fund, said: “Investing, you get what you don’t pay for.”
Don’t put yourself in a situation where short-term declines in the market or in individual stock fortunes can really hurt you. Instead, set yourself up with solid, diversified and inexpensive index funds and you’ll be in a great position to thrive as the economy grows over the long term.