Is this your first stock market crash? Some advice for young investors
There have been a handful of stock market corrections since the Great Financial Crisis ended in 2009 but none of them had the carnage or levels of panic created by the current iteration.
The past 11 years or so have been kind to investors in risk assets so if you’re a young person who is relatively new to investing, this whole ordeal may come as a shock.
Now is as good a time as any to provide some reminders to those investors who may be experiencing their first bout of extreme market volatility:
You have to get used to market crashes
Since 1928, the S&P 500 has experienced 12 different declines of 30% or worse. There have been 20 times when stocks fell at least 20%. These losses have occurred once every 7-8 years and once every 4-5 years, respectively, on average. If you start investing in your 20s or 30s, your investment lifecycle could last six or seven decades when we include retirement years.
I’m 38 years old. Depending on my longevity I probably have 50 years or so ahead of me. In that time I’m expecting probably 10 or so bear markets including 5 or 6 more large market crashes. For those younger than me it will probably be even more.
Unfortunately, this is part of the trade-off when investing in risk assets.
Understand the trade-off between risk and reward
U.S. stocks have finished the year with a loss in 25 out of the past 92 years. The worst of those losses was in 1931, when stocks fell nearly 44%. Three-month t-bills (a proxy for cash or short-term savings rates) have never had a down year.
The safety of cash sounds pretty desirable right about now as stocks are getting hammered. But the trade-off for the relative stability of holding cash is you don’t earn as much in returns. One hundred dollars invested in t-bills in 1928 would have grown to around $2,080 by the end of 2019. That same $100 in the S&P 500 would have grown to more than $500,000.
Risk and reward are attached at the hip. You can’t expect to earn higher returns if you aren’t willing to accept occasional losses and volatility.
Don’t worry about timing the market
There’s an old saying that the stock market is the only business where the product goes on sale and all of the customers run out of the store. The problem is during a market crash, it will always feel like it’s too late to sell but too early to buy.
The good thing about being a young person is you don’t need to worry about timing the market to succeed. You have the ability to wait out bear markets because you have such a long runway in front of you.
The stock market is going to be much higher 30-40 years from now (and if it’s not then we have bigger problems on our hands). Periodic investing or dollar cost averaging into the market over time reduces your risk of making a badly timed purchase by diversifying your retirement contributions across time. And when stocks are down, that means you’ll be buying more shares in the stock market at lower prices.
Saving is more important than investing
Perfect is the enemy of good when creating an investment plan because there is no such thing as a perfect portfolio or investment strategy. The decent strategy you can stick with is vastly superior to the great strategy you can’t stick with.
This is especially true when you’re young and have many decades ahead of you to allow compounding to do the heavy lifting for you.
Just remember that saving money is more important than how you invest when you’re just starting out. You could be the next Warren Buffett as a stock-picker but if you don’t have a high savings rate to take advantage, it doesn’t matter how good you are at investing.
The stock market can help you compound your wealth over time but personal finances are more important than portfolio management, especially when you’re just beginning your investment quest.
Your biggest asset
Buffett is one of the richest people on the planet but young people have a bigger asset than the even Oracle of Omaha—human capital. Human capital represents your future earnings stream and it’s the biggest asset of all for young people because it acts as a representation for time.
Let’s look at an example to show how saving early can positively affect your investment balances in retirement. Sarah decides to start saving for retirement at age 25. She saves $500 a month in her retirement account until age 35. At this point, she stops saving and just let’s compound interest work in her favor. At age 65, assuming a 7% annual rate of return she will retire with approximately $675,000 even though she only contributed $60,000 total into her account.
Jon decides to wait until he is 40 to start saving. He saves the same $500 a month that Sarah did but he actually saves that amount right up until the day he retires. His total amount contributed to his account over those 25 years would be $150,000. Assuming he also earns an annual return of 7% on his funds he will end up with around $406,000 when he retires.
Even though Jon contributed 2.5x as much money as Sarah did, he actually ends up with almost $270,000 less than her at retirement. The best thing you can do as a young person is to start saving and investing as soon as possible to take advantage of your biggest asset.
And the fact that you now get to buy in at lower prices is a good thing over the long haul.
Ben Carlson, CFA is the Director of Institutional Asset Management at Ritholtz Wealth Management. He may own securities or assets discussed in this piece.
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