From a financial perspective, the last several months have been filled with events beyond our control. For younger investors in particular, it can feel difficult to maintain forward progress when so much of the world is filled with uncertainty. In this short article, I wanted to share a few tips that can help you keep positive momentum even during these difficult times.
Develop a Plan, and Stick to It
The foundation of your investment plan should be your emergency fund, held in a high-interest savings money market account. In general, we advise younger investors to save six months worth of living expenses in their emergency fund and only draw from it during true emergencies, such as a vehicle repair or large medical bill.
This emergency fund isn’t glamorous, and it won’t have the same growth potential as other investments, but it can help keep forward momentum during periods of market unrest. We saw this play out during the recent market correction, when some investors were forced to sell stocks to cover their near-term living expenses. Having a buffer between your income and monthly expenses can help you maintain financial progress, even during life’s most challenging moments.
After you’ve established your emergency fund, your excess cash flow each month can be put toward an investment account such as a 401(k), IRA, or brokerage account. Once that happens, the next question we hear from young investors is: when and what should I buy? These questions can often intimidate new investors and cause them to postpone their portfolio contributions.
Successful long-term investing is not about timing the market; it’s about time spent in the market. And while it can feel safe to buy when investor optimism is high and to sell when fear is controlling the market, academic research shows that fear- or greed-based decisions consistently hurt investor performance. Between 1995 and 2015, the S&P 500 index averaged a 9.85% annual return while the average equity fund investor captured just 5.19%. Emotional decision-making was a key factor in this 4% underperformance.1
To reduce the emotional element of investing, we recommend that young investors automate their portfolio contributions, a strategy also known as “dollar-cost averaging.” Automating these contributions is as easy as setting up recurring transfers from your bank account to your portfolio. Dollar-cost averaging eliminates market timing from your investment process since you contribute the same dollar amount to your retirement plan each month — regardless of how the market is performing. As I mentioned in my prior article, you can increase the continuous deposit amounts along with future salary increases and raises.
This strategy can help you invest in the stock market even when it feels the scariest to do so, like in February and March of this year. As Ben Carlson recently said: “the retirement contributions you make into the stock market during a market crash will invariably be the best purchases you ever make, especially when you are still relatively young.”2 He noted that a $100 investment in the S&P 500 during the trough of the 2008 financial crisis is worth over $400 today, while a $100 investment made in the years before and after the 2008 financial crises market collapse would be worth $200 to $250 today. We think that a similar observation will be made when looking back at the COVID-19 pandemic.
Diversify, Diversify, Diversify
Making consistent contributions is a critical part of building long-term wealth, but it is equally important to define what you will be investing in. When you are just getting started, it can be easy to focus on the flashy stocks like Google, Facebook, and Amazon. Many young investors swing for the fences, hoping to find the next “Apple in 2006.”
But the odds of picking a stock that will grow by almost 3,400% (as Apple has) are stacked against you: since 1980, roughly 40% of the stocks in the Russell 3000 index suffered a “catastrophic decline” — meaning they lost at least 70% of their value and never recovered.3 For this reason, we always recommend a diversified approach when determining which investments your money will go toward. A diversified portfolio relies on the performance of hundreds (sometimes thousands) of individual stocks and bonds to generate a return representative of the market. This allows your financial future to be tied to the performance of the US and global economy as a whole, rather than a handful of individual companies.
There is an element of luck in investing, but diversifying your investments is a good way to lower your odds of encountering bad luck. And that’s not to say we should avoid stocks with higher risk and higher return profiles — it just means that these stocks should be used strategically as a small piece within a larger portfolio. After all, it can be fun to pick a few individual stocks within your larger portfolio to follow closely.
We understand that it can be challenging to define and stick to an investment strategy, especially when the markets are so volatile. If you need guidance calculating how much you should be contributing each month to your investment account or help deciding where to invest your hard-earned dollars, we invite you to discuss this with our team. We’ve had the pleasure of helping countless investors during the building-wealth stage of life and would be happy to assist you.